================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2001.
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM______ TO _______.
COMMISSION FILE NUMBER 000-24821
eBay Inc.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 77-0430924
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER)
2145 HAMILTON AVENUE
SAN JOSE, CALIFORNIA 95125
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
(408) 558-7400
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
---------------
Check whether the registrant: (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days.
Yes [X] No [ ]
As of October 31, 2001, there were 275,120,757 shares of the Registrant's
common stock, $0.001 par value, outstanding, which is the only class of common
or voting stock of the Registrant issued as of that date.
PART I: FINANCIAL INFORMATION
ITEM 1: FINANCIAL STATEMENTS
EBAY INC.
CONDENSED CONSOLIDATED BALANCE SHEET
(IN THOUSANDS)
(UNAUDITED)
DECEMBER 31, SEPTEMBER 30,
2000 2001
------------ -------------
ASSETS
Current assets:
Cash and cash equivalents .................................. $ 201,873 $ 423,729
Short-term investments ..................................... 354,166 227,324
Accounts receivable, net ................................... 67,163 97,931
Other current assets ....................................... 52,262 61,494
----------- -----------
Total current assets ..................................... 675,464 810,478
Long-term investments ........................................ 218,197 225,997
Restricted cash and investments .............................. 126,390 129,690
Property and equipment, net .................................. 125,161 142,845
Intangible assets, net ....................................... 13,063 212,929
Deferred tax asset ........................................... 13,892 10,572
Other assets ................................................. 10,236 16,096
----------- -----------
Total assets ........................................... $ 1,182,403 $ 1,548,607
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ........................................... $ 31,725 $ 30,739
Accrued expenses and other current liabilities ............. 66,697 94,890
Deferred revenue and customer advances ..................... 12,656 15,535
Short-term debt ............................................ 15,272 15,958
Income taxes payable ....................................... 11,092 10,981
----------- -----------
Total current liabilities ................................ 137,442 168,103
Long-term debt ............................................... 11,404 12,046
Other liabilities ............................................ 6,549 17,966
Minority interests ........................................... 13,248 39,715
----------- -----------
Total liabilities ...................................... 168,643 237,830
----------- -----------
Contingencies (Note 7)
Stockholders' equity:
Common stock ............................................... 269 275
Additional paid-in capital ................................. 941,285 1,178,942
Unearned stock-based compensation .......................... (1,423) (3,288)
Retained earnings .......................................... 74,504 138,645
Accumulated other comprehensive loss ....................... (875) (3,797)
----------- -----------
Total stockholders' equity ............................... 1,013,760 1,310,777
----------- -----------
Total liabilities and stockholders' equity ............. $ 1,182,403 $ 1,548,607
=========== ===========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
1
EBAY INC.
CONDENSED CONSOLIDATED STATEMENT OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------- -------------------------
2000 2001 2000 2001
------------------------- -------------------------
Net revenues .......................................... $ 113,377 $ 194,425 $ 297,416 $ 529,420
Cost of net revenues .................................. 23,912 34,953 71,499 94,827
------------------------- -------------------------
Gross profit ................................... 89,465 159,472 225,917 434,593
------------------------- -------------------------
Operating expenses:
Sales and marketing ............................... 41,137 66,267 117,728 181,920
Product development ............................... 15,783 20,177 41,721 53,565
General and administrative ........................ 17,948 27,606 55,574 74,538
Payroll tax expense on employee stock options ..... 17 749 1,752 1,561
Amortization of acquired intangible assets ........ 264 12,024 879 24,201
------------------------- -------------------------
Total operating expenses ....................... 75,149 126,823 217,654 335,785
------------------------- -------------------------
Income from operations ................................ 14,316 32,649 8,263 98,808
Interest and other income (expense), net .............. 11,674 9,302 34,223 34,427
Interest expense ...................................... (958) (458) (2,836) (2,129)
Impairment of certain equity investments .............. -- (6,324) -- (16,245)
------------------------- -------------------------
Income before income taxes and minority interests ..... 25,032 35,169 39,650 114,861
Provision for income taxes ............................ (10,141) (19,268) (16,815) (55,971)
Minority interests in consolidated companies .......... 320 2,937 1,594 5,623
------------------------- -------------------------
Net income ............................................ $ 15,211 $ 18,838 $ 24,429 $ 64,513
========================= =========================
Net income per share:
Basic ............................................. $ 0.06 $ 0.07 $ 0.10 $ 0.24
========================= =========================
Diluted ........................................... $ 0.05 $ 0.07 $ 0.09 $ 0.23
========================= =========================
Weighted average shares:
Basic ............................................. 255,741 271,236 249,070 267,116
========================= =========================
Diluted ........................................... 280,297 282,317 280,567 279,614
========================= =========================
The accompanying notes are an integral part of these condensed consolidated
financial statements.
2
EBAY INC.
CONDENSED CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
(IN THOUSANDS)
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------- ----------------------
2000 2001 2000 2001
-------- -------- -------- --------
Net income ............................................................... $ 15,211 $ 18,838 $ 24,429 $ 64,513
-------- -------- -------- --------
Other comprehensive income (loss):
Foreign currency translation ........................................ 1,428 4,167 988 (925)
Unrealized gains (losses) on investments, net ....................... (3,147) 501 (11,663) 2,524
Reclassification of realized gains on investments, net .............. -- 1,411 -- 3,799
Unrealized losses on cash flow hedges ............................... -- (4,005) -- (5,275)
Tax benefit (provision) ............................................. 1,259 837 4,665 (419)
-------- -------- -------- --------
Net change in other comprehensive income (loss) ......................... (460) 2,911 (6,010) (296)
-------- -------- -------- --------
Comprehensive income before cumulative effect of
change in accounting principle ......................................... 14,751 21,749 18,419 64,217
Cumulative effect of change in accounting principle, net of tax .......... -- -- -- (2,626)
-------- -------- -------- --------
Comprehensive income ..................................................... $ 14,751 $ 21,749 $ 18,419 $ 61,591
======== ======== ======== ========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
EBAY INC.
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
NINE MONTHS ENDED
SEPTEMBER 30,
------------------------
2000 2001
------------------------
Cash flows from operating activities:
Net income ....................................................... $ 24,429 $ 64,513
Adjustments:
Provision for doubtful accounts and authorized credits ....... 12,866 18,830
Depreciation and amortization ................................ 27,207 59,916
Amortization of unearned stock-based compensation ............ 6,784 2,184
Tax benefit from the exercise of employee stock options ...... 20,943 53,822
Impairment of certain equity investments ..................... -- 16,245
Minority interests and other ................................. (806) (7,730)
Changes in assets and liabilities:
Accounts receivable ...................................... (25,218) (39,680)
Other current assets ..................................... (12,744) 1,889
Intangible and other assets .............................. (3,050) (5,214)
Deferred tax assets ...................................... (5,248) 2,041
Accounts payable ......................................... (13,337) (6,689)
Accrued expenses and other liabilities ................... 31,519 7,010
Deferred revenue and customer advances ................... 827 1,436
Income taxes payable ..................................... 1,511 (144)
------------------------
Net cash provided by operating activities .......................... 65,683 168,429
------------------------
Cash flows from investing activities:
Purchases of property and equipment .......................... (36,224) (43,677)
Purchases of investments ..................................... (383,080) (350,292)
Maturities and sales of investments .......................... 184,945 522,431
Purchases of other non-current assets ........................ -- (2,065)
Proceeds from sale of property and equipment ................. -- 4,560
Acquisitions, net of cash acquired ........................... -- (111,730)
------------------------
Net cash provided by (used in) in investing activities ............. (234,359) 19,227
------------------------
Cash flows from financing activities:
Proceeds from issuance of common stock, net .................. 39,215 56,869
Proceeds from issuance of common stock by subsidiaries ....... 37,736 --
Principal payments on long-term debt ......................... (506) (21,839)
------------------------
Net cash provided by financing activities .......................... 76,445 35,030
------------------------
Effect of exchange rate changes on cash and cash equivalents ....... 988 (830)
------------------------
Net increase (decrease) in cash and cash equivalents ............... (91,243) 221,856
Cash and cash equivalents at beginning of period ................... 221,801 201,873
------------------------
Cash and cash equivalents at end of period ......................... $ 130,558 $ 423,729
========================
The accompanying notes are an integral part of these condensed consolidated
financial statements.
4
EBAY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1--THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
The Company
eBay Inc. ("eBay") was incorporated in California in May 1996, and
reincorporated in Delaware in April 1998. As of September 30, 2001, eBay had
websites directed towards the United States, Australia, Austria, Belgium,
Canada, France, Germany, Ireland, Italy, Japan, the Netherlands, New Zealand,
South Korea, Spain, Sweden, Switzerland and the United Kingdom. eBay pioneered
online trading by developing a Web-based community in which buyers and sellers
are brought together to buy and sell almost anything. The eBay online service
permits sellers to list items for sale, buyers to bid on items of interest, and
all eBay users to browse through listed items in a fully-automated,
topically-arranged service that is available online seven days a week. eBay has
extended its online offerings to include regional and international trading,
expansion of automobiles to a separate category, "premium" priced items, and now
offers fixed price functionality through Half.com, eBay Stores and its "Buy it
Now" services. eBay also engages in the offline auction business through its
subsidiaries, Butterfields Auctioneers Corporation ("Butterfields") and Kruse,
Inc. d/b/a Kruse International ("Kruse"), and in online payment processing
through its Billpoint, Inc. ("Billpoint") subsidiary.
Use of estimates
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the consolidated
financial statements and the reported amounts of revenues and expenses during
the reporting period. Actual results could differ from those estimates.
Basis of presentation
The accompanying condensed consolidated financial statements as of December
31, 2000 and September 30, 2001, and for the three and nine month periods
ended September 30, 2000 and 2001, respectively, are unaudited. The unaudited
interim condensed consolidated financial statements have been prepared on the
same basis as the annual consolidated financial statements and, in the opinion
of management, reflect all adjustments, which include only normal recurring
adjustments, necessary to present fairly eBay's financial position, as of
September 30, 2001, the results of operations for the three and nine month
periods ended September 30, 2000 and 2001, respectively, and cash flows for the
nine month period ended September 30, 2000 and 2001, respectively. These
condensed consolidated financial statements and notes thereto should be read in
conjunction with eBay's audited consolidated financial statements and related
notes included in eBay's Annual Report on Form 10-K for the year ended December
31, 2000, as filed with the Securities and Exchange Commission on March 28,
2001. The results for interim periods are not necessarily indicative of the
expected results for any other interim period or the year ending December 31,
2001.
Principles of consolidation
The accompanying condensed financial statements include the financial
statements of eBay and its majority owned subsidiaries. All significant
intercompany balances and transactions have been eliminated in consolidation.
Reclassifications
Certain prior period balances and amounts have been reclassified to conform
to the current period presentation.
5
EBAY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
Recent accounting pronouncements
In July 2001, the Financial Accounting Standards Board issued SFAS No. 141,
"Business Combinations," which requires business combinations initiated after
June 30, 2001, be accounted for using the purchase method of accounting and
broadens the criteria for recording intangible assets separate from goodwill.
Recorded goodwill and intangible assets will be evaluated against these new
criteria and may result in certain intangible assets being subsumed into
goodwill, or alternatively, amounts initially recorded as goodwill may be
separately identified and recognized apart from goodwill. Effective July 1,
2001, eBay adopted the provisions of SFAS No. 141 that apply to business
combinations initiated after June 30, 2001. eBay will adopt all remaining
provisions of SFAS No. 141 effective January 1, 2002. The adoption of SFAS No.
141 will not change the method of accounting used in previous business
combinations accounted for under the pooling-of-interest method. eBay is
currently evaluating the effect that adoption of this statement will have on its
financial position, results of operations, and cash flows.
In July 2001, the Financial Accounting Standards Board issued and SFAS No.
142, "Goodwill and Other Intangible Assets," that requires the use of a
non-amortization approach to account for purchased goodwill and certain
intangible assets. Under a non-amortization approach, goodwill and certain
intangible assets will not be amortized as a cost of operations, but instead
would be reviewed for impairment and written down and charged to operations only
in the periods in which the recorded value of goodwill and certain intangible
assets exceed their fair values. This Statement is effective for fiscal years
beginning after December 15, 2001. eBay will adopt SFAS No. 142 effective
January 1, 2002. eBay is currently evaluating the effect that adoption of this
Statement will have on its financial position, results of operations and cash
flows.
In October 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets," that develops one accounting model
for long-lived assets that are to be disposed of by sale and expands the scope
of discontinued operations. This Statement is effective for fiscal years
beginning after December 15, 2001. eBay will adopt SFAS No. 144 effective
January 1, 2002 and is currently evaluating the effect that adoption of this
Statement will have on its financial position, results of operations, and cash
flows.
6
EBAY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 2--NET INCOME PER SHARE:
Basic net income per share is computed by dividing the net income available
to common stockholders for the period by the weighted average number of common
shares outstanding during the period. Diluted net income per share is computed
by dividing the net income for the period by the weighted average number of
common and potential common shares outstanding during the period. Potential
common shares, composed of unvested, restricted common stock and incremental
common shares issuable upon the exercise of stock options and warrants, are
included in the calculation of diluted net income per share to the extent such
shares are dilutive.
The following table sets forth the computation of basic and diluted net
income per share for the periods indicated (in thousands, except per share
amounts):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------ ------------------------
2000 2001 2000 2001
--------- --------- --------- ---------
Numerator:
Net income available to common stockholders .............. $ 15,211 $ 18,838 $ 24,429 $ 64,513
========= ========= ========= =========
Denominator:
Weighted average shares .................................. 267,213 273,822 266,272 271,336
Weighted average common shares subject to repurchase ..... (11,472) (2,586) (17,202) (4,220)
--------- --------- --------- ---------
Denominator for basic calculation ........................ 255,741 271,236 249,070 267,116
Weighted average effect of dilutive securities:
Warrants ................................................. 94 94 94 94
Weighted average common shares subject to repurchase ..... 11,472 2,586 17,202 4,220
Incremental shares from employee stock options ........... 12,990 8,401 14,201 8,184
--------- --------- --------- ---------
Denominator for diluted calculation ...................... 280,297 282,317 280,567 279,614
========= ========= ========= =========
Net income per share:
Basic .................................................... $ 0.06 $ 0.07 $ 0.10 $ 0.24
========= ========= ========= =========
Diluted .................................................. $ 0.05 $ 0.07 $ 0.09 $ 0.23
========= ========= ========= =========
NOTE 3--ACQUISITIONS:
Internet Auction Acquisition
On February 15, 2001, eBay acquired a majority interest in Internet Auction
Co., Ltd., a South Korean company ("Internet Auction"), in a $121.9 million
transaction accounted for as a purchase business combination. The results of
operations of Internet Auction have been included in eBay's consolidated
financial statements from February 15, 2001.
7
EBAY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
On May 18, 2001, eBay completed its acquisition of iBazar S.A. ("iBazar")
in a $125.6 million transaction accounted for as a purchase business
combination. The results of operations of iBazar have been included in eBay's
consolidated financial statements from May 18, 2001.
In accordance with EITF Issue No. 95-3, Recognition of Liabilities in
Connection with a Purchase Business Combination, eBay had established plans to
exit certain activities of iBazar, resulting in terminations of certain iBazar
employees. In accordance with this exit plan, approximately $2 million was
accrued for the estimated costs associated with severance, contract terminations
and financial advisory and legal fees at June 30, 2001 and has been included in
net tangible assets. As of September 30, 2001, $399,000 has been charged against
this accrued liability.
The following unaudited pro forma financial information presents the
combined results of eBay, Internet Auction and iBazar as if the acquisitions had
occurred as of the beginning of 2000 and 2001, respectively, after giving effect
to certain adjustments, including amortization of goodwill and other acquisition
related transactions (in thousands except per share amounts):
NINE MONTHS ENDED
SEPTEMBER 30,
----------------------
2000 2001
----------------------
Net revenues ........................................ $303,073 $534,174
======== ========
Net income (loss) ................................... $(41,845) $ 47,197
======== ========
Net income (loss) per share:
Basic ............................................... $ (0.17) $ 0.18
======== ========
Diluted ............................................. $ (0.17) $ 0.17
======== ========
The pro forma financial information does not necessarily reflect the results
of operations that would have occurred had eBay, Internet Auction and iBazar
constituted a consolidated entity during such periods.
In September 2001, eBay entered into a strategic business relationship with
MercadoLibre, a leading online auction site serving Latin America. In exchange
for its equity interest in iBazar Com Ltda, a Brazilian subsidiary of iBazar,
eBay received a 19.5% ownership interest in MercadoLibre. eBay will account for
its investment in MercadoLibre using the cost method.
8
EBAY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 4--SEGMENT INFORMATION:
eBay has two primary reporting segments: online trading services, consisting
primarily of auction style and fixed price trading, payment processing,
advertising, and end-to-end services; and offline, which includes the
traditional auction services of Butterfields and Kruse.
Segment selection is based upon the internal organization structure, the
manner in which these operations are managed and their performance evaluated by
management, the availability of separate financial information and overall
materiality considerations. Segment performance measurement is based on
operating income or loss before amortization of acquired intangible assets,
merger-related costs, stock-based cost and expenses, impairment of certain
equity investments and payroll tax on employee stock options.
9
EBAY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
The operating information for the two reporting segments are as follows (in
thousands):
THREE MONTHS ENDED SEPTEMBER 30,
---------------------------------------------------------------------------------------
2000 2001
------------------------------------------ ------------------------------------------
ONLINE OFFLINE CONSOLIDATED ONLINE OFFLINE CONSOLIDATED
----------- ----------- ------------ ----------- ----------- ------------
Net revenues from external customers ..... $ 102,839 $ 10,538 $ 113,377 $ 185,448 $ 8,977 $ 194,425
=========== =========== =========== =========== =========== ===========
Operating income (loss) before
amortization of acquired intangible
assets, merger related costs,
stock-based cost and expenses,
impairment of certain equity
investments and payroll tax on
employee stock options ................. $ 18,868 $ (321) $ 18,547 $ 46,856 $ (1,015) $ 45,841
Interest and other income and
expense, net ........................... 11,451 223 11,674 9,258 44 9,302
Impairment of certain equity
investments ............................ -- -- -- (6,324) -- (6,324)
Interest expense ......................... (284) (674) (958) (10) (448) (458)
Amortization of acquired intangible
assets, merger related costs,
stock-based cost and expenses and
payroll tax on employee
stock options .......................... (4,137) (94) (4,231) (13,087) (105) (13,192)
----------- ----------- ----------- ----------- ----------- -----------
Income (loss) before income taxes and
minority interests ..................... $ 25,898 $ (866) $ 25,032 $ 36,693 $ (1,524) $ 35,169
=========== =========== =========== =========== =========== ===========
NINE MONTHS ENDED SEPTEMBER 30,
---------------------------------------------------------------------------------------
2000 2001
------------------------------------------ ------------------------------------------
ONLINE OFFLINE CONSOLIDATED ONLINE OFFLINE CONSOLIDATED
----------- ----------- ------------ ----------- ----------- ------------
Net revenues from external customers ..... $ 268,850 $ 28,566 $ 297,416 $ 502,809 $ 26,611 $ 529,420
=========== =========== =========== =========== =========== ===========
Operating income (loss) before
amortization of acquired intangible
assets, merger related costs,
stock-based cost and expenses,
impairment of certain equity
investments and payroll tax on
employee stock options ................. $ 20,311 $ (3,018) $ 17,293 $ 127,618 $ (848) $ 126,770
Interest and other income and
expense, net ........................... 33,659 564 34,223 35,155 (728) 34,427
Impairment of certain equity
investments ............................ -- -- -- (16,245) -- (16,245)
Interest expense ......................... (1,026) (1,810) (2,836) (1,681) (448) (2,129)
Amortization of acquired intangible
assets, merger related costs,
stock-based cost and expenses and
payroll tax on employee stock
options ................................ (8,130) (900) (9,030) (27,699) (263) (27,962)
----------- ----------- ----------- ----------- ----------- -----------
Income (loss) before income taxes and
minority interests .................... $ 44,814 $ (5,164) $ 39,650 $ 117,148 $ (2,287) $ 114,861
=========== =========== =========== =========== =========== ===========
DECEMBER 31, 2000 SEPTEMBER 30, 2001
------------------------------------------ ------------------------------------------
ONLINE OFFLINE CONSOLIDATED ONLINE OFFLINE CONSOLIDATED
----------- ----------- ------------ ----------- ----------- ------------
Total assets ............................. $ 1,084,909 $ 97,494 $ 1,182,403 $ 1,456,438 $ 92,169 $ 1,548,607
=========== =========== =========== =========== =========== ===========
10
EBAY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 5--INVESTMENTS:
At December 31, 2000 and September 30, 2001, short and long-term investments
are composed as follows (in thousands):
DECEMBER 31, 2000
--------------------------------------------------
GROSS GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- ---------- --------
Short-term investments:
Municipal bonds and notes ......... $112,488 $ 15 $ (116) $112,387
Corporate securities .............. 21,193 70 -- 21,263
Government securities ............. 219,674 842 -- 220,516
------- -------- -------- --------
Total .......................... $353,355 $ 927 $ (116) $354,166
======== ======== ======== ========
Long-term investments:
Municipal bonds and notes ......... $141,861 $ 69 $ (269) $141,661
Government securities ............. 122,900 694 (81) 123,513
Restricted cash ................... 28,832 -- -- 28,832
Equity instruments ................ 54,505 -- (3,924) 50,581
-------- -------- -------- --------
Total .......................... $348,098 $ 763 $ (4,274) $344,587
======== ======== ======== ========
SEPTEMBER 30, 2001
--------------------------------------------------
GROSS GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- ---------- --------
Short-term investments:
Municipal bonds and notes ......... $182,065 $ 1,146 $ (3) $183,208
Government securities ............. 4,994 26 -- 5,020
Time deposits and other ........... 39,106 -- (10) 39,096
-------- -------- -------- --------
Total .......................... $226,165 $ 1,172 $ (13) $227,324
======== ======== ======== ========
Long-term investments:
Municipal bonds and notes ......... $ 7,390 $ 33 $ -- $ 7,423
Government securities ............. 229,536 2,259 -- 231,795
Restricted cash ................... 89,778 -- -- 89,778
Equity instruments ................ 26,520 171 -- 26,691
-------- -------- -------- --------
Total .......................... $353,224 $ 2,463 $ -- $355,687
======== ======== ======== ========
As of December 31, 2000 and September 30, 2001, long-term investments
include restricted cash of $28.8 million and $89.8 million, respectively, and
restricted investments held in government securities of $97.3 million and
$39.9 million, respectively. With the exception of restricted cash, investments
are generally classified as held to maturity.
11
EBAY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
The estimated fair values of short and long-term investments at September
30, 2001, classified by date of contractual maturity are as follows (in
thousands):
SEPTEMBER 30,
2001
-------------
Due within one year or less .......................................... $227,324
Due after one year through two years ................................. 62,652
Due after two years through three years .............................. 136,654
Due after three years through four years ............................. --
Restricted cash and investments expiring in less than five years ..... 129,690
Equity investments ................................................... 26,691
--------
$583,011
========
In accordance with eBay's policy to assess whether an impairment loss on its
investments has occurred due to declines in fair value and other market
conditions, eBay determined that declines in fair value of certain of its equity
investments were other than temporary. Accordingly, eBay recorded impairment
charges totaling $6.3 million and $16.2 million during the three and nine months
ended September 30, 2001, respectively, relating to the other than temporary
impairment in the fair value of certain equity investments.
NOTE 6--DERIVATIVE INSTRUMENTS:
eBay monitors and manages its financial exposures as an integral part of its
overall risk-management program. eBay uses derivative instruments to minimize
earnings fluctuations that may arise from volatility in U.S. interest rates.
eBay entered into two interest rate swaps on June 19 and July 20, 2000, with
notional amounts of $45 million and $50 million that allow eBay to receive
floating rate receipts based on London Interbank Offering Rate ("LIBOR") in
exchange for making fixed rate payments of approximately 7% of the notional
amount. These interest rate swaps effectively change the interest rate exposure
on a portion of the operating lease payments relating to eBay's corporate office
facilities from a floating rate to a fixed rate on $95 million of the total
$126.4 million operating lease, with the balance of $31.4 million remaining at a
floating rate of interest based on the spread over 3-month LIBOR. The fair value
of the interest rate swaps as of September 30, 2001 was an unrealized loss of
$9.7 million.
During the three months and nine months ended September 30, 2001, the
ineffective portion of the interest rate swaps was not material. During the
three months and nine months ended September 30, 2001, $4.0 million and $1.4
million of losses on the interest rate swaps was classified to other
comprehensive income, respectively. The derivative losses reclassified into rent
expense were offset by decreases in rent expense relating to the operating
lease. At September 30, 2001, eBay expects to reclassify $2.6 million of losses,
net of tax, on the interest rate swaps from accumulated other comprehensive
income to rent expense during the next twelve months.
eBay adopted SFAS No. 133, as amended, as of January 1, 2001. Upon adoption,
the cumulative effect on net income and other comprehensive income of this
change in accounting method relating to the interest rate swaps was a gain of
approximately $650,000 included in other income and expense, net, and a loss of
approximately $2.6 million, respectively, net of tax.
In addition to the interest rate swaps used in the cash flow hedging
strategy described above, eBay owns equity warrants and other similar rights in
certain companies as part of eBay's strategic investment strategy. These equity
rights are accounted for as derivative instruments under SFAS No. 133 and the
changes in fair value of these instruments are reflected in current period
earnings in the income statement and classified as other income and expense,
net. The fair value of the warrants as of September 30, 2001, was not material
to eBay's financial statements.
12
EBAY INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
NOTE 7--CONTINGENCIES:
Legal Matters
On April 25, 2000, eBay was served with a lawsuit, Gentry et.al. v. eBay,
Inc. et.al, filed in Superior Court in San Diego, California. The lawsuit was
filed on behalf of a purported class of eBay users who purchased allegedly
forged autographed sports memorabilia on eBay. The lawsuit claims eBay was
negligent in permitting certain named (and other unnamed) defendants to sell
allegedly forged autographed sports memorabilia on eBay. In addition, the
lawsuit claims eBay violated California unfair competition law and a section of
the California Civil Code which prohibits "dealers" from selling sports
memorabilia without a "Certificate of Authenticity." On January 26, 2001, the
court issued a ruling dismissing all claims against eBay in the lawsuit. The
court ruled that eBay's business falls within the safe harbor provisions of 47
USC 230, which grants Internet service providers such as eBay with immunity from
state claims based on the conduct of third parties. The court also noted that
eBay was not a "dealer" under California law and thus not required to provide
certificates of authenticity with autographs sold over our site by third
parties. All counts of the plaintiffs' suit were dismissed with prejudice as to
eBay. The plaintiffs have appealed this ruling. eBay believes it has meritorious
defenses and intends to defend itself vigorously.
On April 25, 2001, eBay's European subsidiaries, eBay GmbH and eBay
International AG, were sued by Montres Rolex S.A. and certain Rolex affiliates
("Rolex") in the regional court of Cologne, Germany. Rolex alleged that eBay's
subsidiaries were infringing Rolex's trademarks as result of users selling
counterfeit Rolex watches through its German website. The suit also alleges
unfair competition. Rolex is seeking an order forbidding the sale of Rolex
watches on the website as well as damages. eBay believes that it has meritorious
defenses against this claim and intends to defend itself vigorously.
Other third parties have from time to time claimed, and others may claim in
the future, that eBay has infringed their past, current or future intellectual
property rights. eBay has in the past been forced to litigate such claims. eBay
may become more vulnerable to such claims as laws such as the Digital Millennium
Copyright Act are interpreted by the courts and as eBay expands into
jurisdictions where the underlying laws with respect to the potential liability
of online intermediaries like itself are less favorable. eBay expects that it
will increasingly be subject to infringement claims as the geographical reach of
its services expands. These claims, whether meritorious or not, could be
time-consuming, result in costly litigation, cause service upgrade delays,
require expensive changes in eBay's methods of doing business or could require
eBay to enter into costly royalty or licensing agreements, if available. As a
result, these claims could harm eBay's business.
On September 26, 2001 a complaint was filed by MercExchange LLC against
eBay, its Half.com subsidiary and ReturnBuy, Inc. in the Eastern District of
Virginia (No. 2:01-CV-736) alleging infringement of three patents and seeking a
permanent injunction and damages (including treble damages for willful
infringement). eBay has answered this complaint, denying the allegations, and it
believes it has meritorious defenses and will defend itself vigorously. However,
even if successful, eBay's defense against this action could be costly and
divert management's time. If the plaintiff was to prevail on all of its claims,
eBay might be forced to pay significant damages and licensing fees, modify its
business practices or even be enjoined from practicing a significant part of its
U.S. business. Any such results could materially harm eBay's business.
From time to time, eBay is involved in other disputes that arise in the
ordinary course of business. eBay believes that the ultimate resolution of these
other disputes will not have a material adverse impact on its financial
position, results of operations, or cash flows.
13
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FORWARD LOOKING STATEMENTS
This document contains certain forward-looking statements that involve risks
and uncertainties, such as statements of our plans, objectives, expectations and
intentions. When used in this document, the words "expects", "anticipates",
"intends", "plans" and similar expressions are intended to identify certain of
these forward-looking statements. The cautionary statements made in this
document should be read as being applicable to all related forward-looking
statements wherever they appear in this document. Our actual results could
differ materially from those discussed in this document. Factors that could
cause or contribute to such differences include those discussed below.
OVERVIEW
We pioneered online person-to-person trading by developing a global online
trading platform that helps practically anyone buy or sell practically anything.
Our service permits sellers to list items for sale, buyers to bid on items of
interest and all eBay users to browse through listed items in a fully automated,
topically arranged, intuitive and easy-to-use online service that is available
seven days a week. We have extended our online offerings to include regional and
international trading, expansion of automobiles to a separate category,
"premium" priced items, and we now offer fixed-price functionality through
Half.com, eBay Stores and our "Buy it Now" services. Additionally, we provide
online billing and payment solutions. We also have a traditional auction
business, also called offline trading, through our Butterfields and Kruse
subsidiaries.
A substantial portion of our revenues are derived from fees and commissions
associated with online and offline trading services. Online revenue is primarily
derived from listing fees, feature fees and final value fees paid by the
sellers, and commissions paid by buyers for certain "premium" priced items.
Sellers pay a placement fee, and by paying additional fees, sellers can have
items featured in various ways. Sellers also pay a success fee based on the
final purchase price. In addition, we generate revenue from third party
advertising and end-to-end services and promotions. We also generate fees from
payment services and fixed price trading. Although we expect end-to-end and
direct advertising revenues to increase in the future, they are subject to
considerable uncertainty. See "Risk Factors -- Our revenue from third party
advertising and end-to-end services and promotions is subject to factors beyond
our control." Offline revenue is derived from a variety of sources, including
sellers' commissions, buyers' premiums, bidder registration fees and
auction-related services, including appraisal and authentication. We expect that
the online business will continue to represent the majority of revenue growth in
the foreseeable future.
ACQUISITIONS
On February 15, 2001, we acquired a majority interest in Internet Auction
Co., Ltd., a South Korean company ("Internet Auction"), in a $121.9 million
transaction accounted for as a purchase business combination. The results of
operations of Internet Auction have been included in our consolidated financial
statements from February 15, 2001.
14
On May 18, 2001, we completed our acquisition of iBazar S.A. ("iBazar") in a
$125.6 million transaction accounted for as a purchase business combination. The
results of operations of iBazar have been included in our consolidated financial
statements from May 18, 2001.
In accordance with EITF Issue No. 95-3, Recognition of Liabilities in
Connection with a Purchase Business Combination, we have established plans to
exit certain activities of iBazar resulting in the terminations of certain
iBazar employees. In accordance with this exit plan, approximately $2 million
was accrued for the estimated costs associated with severance, contract
terminations and financial advisory and legal fees at June 30, 2001 and has been
included in net tangible assets. As of September 30, 2001, $399,000 has been
charged against this accrued liability.
In September 2001, we entered into a strategic business relationship with
MercadoLibre, a leading online auction site serving Latin America. In exchange
for our equity interest in iBazar Com Ltda, a Brazilian subsidiary of iBazar, we
received a 19.5% ownership interest in MercadoLibre. We will account for our
investment in MercadoLibre using the cost method.
RESULTS OF OPERATIONS
It is difficult for us to forecast revenues or earnings accurately, and the
operating results in one or more future quarters may fall below the expectations
of securities analysts or investors. Although accurate revenue forecasts are
difficult, we recognize the seasonal nature of our business because many of our
users reduce their activities on our websites during the Thanksgiving and
Christmas holidays and with the onset of good weather. We have historically
experienced our strongest quarter of online growth in our first fiscal quarter,
although our shift to more "practical" items may cause our seasonal patterns to
look more like those of a typical retailer. Both Butterfields and Kruse have
significant quarter-to-quarter variations in their results of operations
depending on the timing of auctions and the availability of high quality items
from large collections and estates. Butterfields typically has its best
operating results in the traditional fall and spring auction seasons and has
historically incurred operating losses in the first and third quarters. Kruse
typically sees a seasonal peak in operations in the third quarter. Seasonal or
cyclical variations in our business may become more pronounced over time and may
harm our results of operations in the future.
Due to the inherent difficulty in forecasting net revenues, it is also
difficult to forecast income statement expense categories as a percentage of net
revenues. Quarterly and annual income statement expense categories as a
percentage of net revenues may be significantly different from historical or
projected rates. As a general note, we expect costs to increase in absolute
dollars across all income statement categories.
To a large extent, the changes in the consolidated results of operations for
the periods presented are due to the growth of the online business, which will
be the primary focus of our discussion.
15
Net Revenues
We derive revenue from a variety of sources, including listing, feature and
final value fees; payment processing; third party advertising; and end-to-end
services and promotions. In addition, we derive commissions and rental income
from our traditional offline auction operations. Net revenues for the three and
nine month periods ended September 30, 2001, increased 71% and 78%,
respectively, from the comparable 2000 periods. These increases were primarily
the result of increased online activity, reflected in the growth in the number
of registered users, listings and gross merchandise sales, as well as increased
third party advertising revenues. Fee increases in the U.S. on January 31, 2001
and fee increases in various other international locations, combined with the
consolidation of revenues from Internet Auction and iBazar, also had a positive
impact on revenues for the quarter. Revenues from third party advertising
increased from 2% of net revenues for the three months ended September 30, 2000
to 13% of net revenues for the same period of 2001, and up from 10% for the
three months ended June 30, 2001. For the nine months ended September 30, 2000,
third party advertising accounted for 3% of net revenues, compared to 11% for
the same period of 2001. These revenues have increased primarily as a result of
our strategy to increase site monetization through our marketing and advertising
service agreement with AOL Time Warner. However, we continue to view our
business as primarily transaction driven and over the longer term we do not
expect advertising revenues to significantly increase as a percentage of total
net revenues. International revenues accounted for 7% and 16% of net revenues
during the three month periods ended September 30, 2000 and 2001, respectively,
and 6% and 14% of net revenues during the nine months ended September 30, 2000
and 2001, respectively. We expect the trend of increasing international revenues
to continue as we build out our worldwide marketplace. We also expect that
future revenue growth will be largely driven by the growth of online services.
During the three and nine month periods ended September 30, 2001, offline
revenues have decreased in both absolute dollars and as a percentage of net
revenues compared to the corresponding 2000 periods, partly as a result of a
general softening in the offline auction market.
Cost of Net Revenues
Cost of net revenues for online operations consists primarily of costs
associated with customer support and site operations and includes employee and
facilities costs for customer support and site operations personnel, ISP
connectivity charges and depreciation on site equipment. Cost of net revenues in
traditional auction operations primarily includes compensation for auction,
appraisal, and customer support personnel and direct auction costs, such as
event site rental. Cost of net revenues increased in absolute dollars but
decreased as a percentage of net revenues from $23.9 million or 21% of net
revenues to $35.0 million or 18% of net revenues for the three months ended
September 30, 2000 and 2001, respectively. Cost of net revenues similarly
increased in absolute dollars but decreased as a percentage of net revenues from
$71.5 million or 24% of net revenues for the nine months ended September 30,
2000 to $94.8 million or 18% of net revenues for the same period in 2001. The
increases in absolute dollars in expenditures were due almost entirely to our
online businesses, and resulted from the continued development and expansion of
our customer support and site operations departments, depreciation of the
equipment required for site operations, software licensing fees and ISP
connectivity charges. The decrease in cost of net revenues as a percentage of
net revenues from 2000 to 2001, resulted from improved productivity and cost
management in customer support and site operations and increases in higher gross
margin businesses such as autos, end-to-end trading solutions and advertising.
As a result of these efficiencies, we expect the cost of net revenues to
increase in absolute dollars but remain below 20% as a percentage of net
revenues throughout the remainder of 2001.
16
Sales and Marketing
Sales and marketing expenses for both the online and offline auction
businesses are comprised primarily of compensation for our category development
and marketing staff, advertising, tradeshow and other promotional costs, and
facilities costs. Sales and marketing expenses increased in absolute dollars but
decreased as a percentage of net revenues from $41.1 million or 36% of net
revenues to $66.3 million or 34% of net revenues for the three months ended
September 30, 2000 and 2001, respectively. Sales and marketing increased in
absolute dollars but decreased as a percentage of net revenues from $117.7
million or 40% of net revenues for the nine months ended September 30, 2000 to
$181.9 million or 34% of net revenues for the same period of 2001. The growth
from 2000 to 2001 was primarily the result of growth in online and traditional
advertising, including expenses for various marketing agreements, staff related
costs, costs associated with the use of outside services and consultants and
miscellaneous user and promotional costs.
Online sales and marketing expenses are expected to increase in absolute
dollars for the remainder of 2001. We expect to build our brand further with
continued advertising delivered under our strategic alliances with various third
parties and the expansion of international advertising. Sales and marketing
expenses in the offline auction businesses are expected to remain comparable
with historic levels.
Product Development
Product development expenses consist primarily of compensation for our
product development staff, payments to outside contractors, depreciation on
equipment used for development, other employee and facilities costs. Product
development expenses increased in absolute dollars but decreased as a percentage
of net revenues from $15.8 million or 14% of net revenues to $20.2 million or
10% of net revenues for the three months ended September 30, 2000 and 2001,
respectively. Product development expenses similarly increased in absolute
dollars and decreased as a percentage of net revenues from $41.7 million or 14%
of net revenues for the nine months ended September 30, 2000 to $53.6 million or
10% of net revenues for the same period of 2001. The growth in product
development cost from 2000 to 2001 was primarily the result of an increase in
staff-related costs as we increased the size of our product development team,
expenses related to contractors and consultants employed within product
development departments, maintenance and depreciation of equipment used in
research and development, and costs associated with the development of our next
generation architecture, which did not meet the criteria for capitalization. The
increase also resulted from the growth of product development expenses at our
Half.com subsidiary. Product development expenses are expected to increase in
absolute dollars during future periods primarily from personnel additions, the
continued impact of investments in our fixed price and payment businesses,
additional depreciation costs as we continue to purchase equipment to improve
and expand domestic and international operations and certain costs associated
with the development of our next generation architecture.
General and Administrative
General and administrative expenses consist primarily of compensation for
personnel and, to a lesser extent, fees for external professional advisors,
provisions for doubtful accounts, employee and facilities costs. General and
administrative expenses increased in absolute dollars but decreased as a
percentage of net revenues from $17.9 million or 16% of net revenues to $27.6
million or 14% of net revenues for the three months ended September 30, 2000 and
2001, respectively. General and administrative costs similarly increased in
absolute dollars and decreased as a percentage of net revenues from $55.6
million or 19% of net revenues for the nine months ended September 30, 2000 to
$74.5 million or 14% of net revenues for the same period in 2001. The
year-over-year increases resulted from growth in personnel-related expenses to
meet the demands of our expanding business, including operations in new
countries and the integration of new businesses, fees for professional services,
employee and facilities costs. We expect that general and administrative
expenses will increase in absolute dollars in future periods as we continue to
invest in the infrastructure that is necessary to manage our business.
Payroll Tax Expense on Employee Stock Options
We are subject to employer payroll tax expense on certain employee exercises
of non-qualified stock options. These employer payroll taxes are recorded as a
charge to operations in the period such options are exercised and sold based on
gains at the date of exercise. Payroll taxes on employee stock options increased
from $17,000 or less than 1% of net revenues to $749,000 or less than 1% of net
revenues for the three months ended September 30, 2000 and 2001, respectively.
Payroll taxes on employee stock options decreased from $1.8 million or 1% of net
revenues for the nine months ended September 30, 2000 to $1.6 million or less
than 1% of net revenues for the same period in 2001. Our
17
quarterly results of operations and cash flows could vary significantly
depending on the actual period in which the stock options are exercised by
employees and, consequently, the amount of employer payroll taxes assessed.
Amortization of Acquired Intangible Assets
From time to time we have purchased, and expect to continue purchasing,
assets or businesses to support our leadership role in online trading. These
purchases may result in the creation of intangible assets and lead to a
corresponding increase in related amortization expense. Amortization of acquired
intangible assets increased from $264,000 or less than 1% of net revenues to
$12.0 million or 6% of net revenues for the three months ended September 30,
2000 and 2001, respectively. Amortization of acquired intangible assets
increased from $879,000 or less than 1% of net revenues for the nine months
ended September 30, 2000 to $24.2 million or 5% of net revenues for the same
period of 2001. The increase resulted primarily from our purchase of a majority
interest in Internet Auction and the acquisition of iBazar. We expect the
amortization of intangible assets to continue to increase in 2001 due to
on-going amortization related to Internet Auction and iBazar.
In July 2001, the Financial Accounting Standards Board issued and SFAS No.
142, "Goodwill and Other Intangible Assets," that requires the use of a
non-amortization approach to account for purchased goodwill and certain
intangible assets. Under a non-amortization approach, goodwill and certain
intangible assets will not be amortized into results of operations, but instead
would be reviewed for impairment and written down and charged to results of
operations only in the periods in which the recorded value of goodwill and
certain intangible assets exceed their fair values. This Statement is effective
for fiscal years beginning after December 15, 2001. We will adopt SFAS No. 142
effective January 1, 2002.
Interest and Other Income and Expense, Net
Interest and other income and expense, net consists of interest earned on
cash, cash equivalents and investments and foreign exchange transaction gains
and losses. Interest and other income and expense, net decreased from $11.7
million or 10% of net revenues to $9.3 million or 5% of net revenues for the
three months ended September 30, 2000 and 2001, respectively, primarily as a
result of the decrease in the average invested balance due to the cash outflow
for the purchase of a majority interest in Internet Auction. Interest and other
income and expense, net increased in absolute dollars but decreased as a
percentage of net revenues from $34.2 million or 12% of net revenues for the
three months ended September 30, 2000 to $34.4 million or 7% of net revenues for
the same period in 2001, primarily as a result of the increase in the average
balance that was invested during the first three months of 2001. Losses from the
change in the fair value of equity warrants were not material to our financial
position, results of operations, or cash flows.
Impairment of Certain Equity Investments
As part of our overall business strategy, we have invested and will continue
to invest in companies that we consider to be of strategic value. Due to the
general downturn in the economy and the financial difficulties that some of
these companies have experienced, we have concluded that the reduction in the
fair value of certain of these investments was other than temporary and recorded
impairment charges of $9.9 million during the three months ended March 31, 2001,
and $6.3 million during the three months ended September 30, 2001.
Interest Expense
Interest expense consists of interest paid on short-term and long-term
borrowings. Interest expense decreased from $958,000 or 1% of net revenues to
$458,000 or less than 1% of net revenues for the three months ended September
30, 2000 and 2001, respectively and from $2.8 million or 1% of net revenues for
the nine months ended September 30, 2000 to $2.1 million or less than 1% of net
revenues for the same period in 2001. The decrease in interest expense is due to
a combination of a decrease in the average interest rate on borrowings and the
prepayment of a borrowing related to a lease by Internet Auction made during
2001.
18
Provision for Income Taxes
Our effective income tax rates were 40% and 51% in the three months ended
September 30, 2000 and 2001, respectively, and 41% and 46% in the nine months
ended September 30, 2000 and 2001, respectively. The increase in the effective
rate for the three and nine months ended September 30, 2001, compared to the
same period last year is primarily due to certain nondeductible expenses related
to acquisitions and is partially offset by income from operations in foreign
jurisdictions with lower effective tax rates. The provision for income taxes for
both periods differs from the amount computed by applying the statutory U.S.
federal rate principally due to state taxes, tax exempt interest income and
nondeductible expenses. We receive tax deductions from gains realized by
employees on the exercise of certain non-qualified stock options for which the
benefit is recognized as a component of paid-in capital. We have provided a
valuation allowance on the deferred tax assets relating to these stock option
deductions.
Stock-Based Compensation
In connection with granting certain stock options from May 1997 through May
1999, we recorded aggregate unearned compensation totaling $13.1 million, which
is being amortized over the four-year vesting period of the related options. In
connection with certain stock options granted by companies that we subsequently
acquired, we recorded unearned compensation totaling $9.3 million. Amortization
of unearned stock compensation was approximately $3.4 million for the three
months ended September 30, 2000, $676,000 for the three months ended September
30, 2001 and $6.8 million and $2.2 million respectively for the nine months
ended September 30, 2000 and 2001, respectively. As of September 30, 2001,
unearned compensation totaling $3.3 million was recorded as a component of
stockholders' equity and will be amortized as a charge against earnings over the
remaining vesting period of the related options.
LIQUIDITY AND CAPITAL RESOURCES
Since inception, eBay has financed operations primarily from net cash
generated from operating activities. We obtained additional financing from the
sale of preferred stock and warrants, proceeds from the exercise of those
warrants, proceeds from the exercise of stock options, and proceeds from our
initial and follow-on public offerings.
Net cash provided by operating activities was $65.7 million and $168.4
million for the nine months ended September 30, 2000 and 2001, respectively. Net
cash provided by operating activities resulted primarily from our net income
before non-cash charges for depreciation and amortization, tax benefit from
employee stock options and impairment of certain equity investments offset by
changes in assets and liabilities, primarily accounts receivable.
Net cash used in investing activities was $234.4 million for the nine months
ended September 30, 2000, and net cash provided by investing activities was
$19.2 million for the same period in 2001. In 2000, the primary use for invested
cash in the periods presented was purchases of investments and property and
equipment. In 2001, net cash provided by the maturity of certain short-term
investments was partially offset by the cash paid for the acquisition of a
majority interest in Internet Auction and the purchase of investments.
Net cash provided by financing activities was $76.4 million for the nine
months ended September 30, 2000 and $35.0 million for the same period in 2001.
In 2000, net cash provided in financing activities resulted primarily from the
issuance of common stock to third parties by our subsidiaries and the sale of
common stock under employee stock option plans. In 2001, net cash provided in
financing activities primarily resulted from the issuance of common stock under
employee stock option and stock purchase plans.
We had no material commitments for capital expenditures at September 30,
2001, but expect such expenditures to approximate $16.2 million throughout the
remainder of 2001, without taking into account any acquisitions. Of the $16.2
million, approximately $3.7 million has been allocated to capital expenditures
relating to hardware and software for the development of our next generation
site architecture. The remaining balance will be used primarily for computer
equipment, furniture and fixtures and leasehold improvements. In August 2001, we
amended our Interactive Marketing and Advertising Representation agreements with
AOL Time Warner. The amendments extend the term of the relationship through
March 2004, provide additional exclusivity for AOL Time Warner and do not result
in a material change to our projected operating results and liquidity. In
February 2000, we signed a promotional agreement with certain affiliates of The
Walt Disney Company ("Disney") then known as GO.com. GO.com was subsequently
reorganized by Disney and we have renegotiated our agreement. The revised
agreement does not result in a material change to our projected operating
results and liquidity.
19
We believe that existing cash, cash equivalents and investments, and any
cash generated from operations will be sufficient to fund our operating
activities, capital expenditures and other obligations for the foreseeable
future. However, if during that period or thereafter we are not successful in
generating sufficient cash flow from operations or in raising additional capital
when required in sufficient amounts and on terms acceptable to us, our business
could suffer.
RECENT ACCOUNTING PRONOUNCEMENTS
In July 2001, the Financial Accounting Standards Board issued SFAS No. 141,
"Business Combinations," which requires business combinations initiated after
June 30, 2001, be accounted for using the purchase method of accounting and
broadens the criteria for recording intangible assets separate from goodwill.
Recorded goodwill and intangible assets will be evaluated against these
new criteria and may result in certain intangible assets being subsumed into
goodwill, or alternatively, amounts initially recorded as goodwill may be
separately identified and recognized apart from goodwill. Effective July 1,
2001, we adopted the provisions of SFAS No. 141 that apply to business
combinations initiated after June 30, 2001. We will adopt all remaining
provisions of SFAS No. 141 effective January 1, 2001. The adoption of SFAS
No. 141 will not change the method of accounting used in previous business
combinations accounted for under the pooling-of-interest method. We are
currently evaluating the effect that adoption of this statement will have on
our financial position, results of operations, and cash flows.
In July 2001, the Financial Accounting Standards Board issued and SFAS No.
142, "Goodwill and Other Intangible Assets," that requires the use of a
non-amortization approach to account for purchased goodwill and certain
intangible assets. Under a non-amortization approach, goodwill and certain
intangible assets will not be amortized as a cost of operations, but instead
would be reviewed for impairment and written down and charged to operations only
in the periods in which the recorded value of goodwill and certain intangible
assets exceed their fair values. This Statement is effective for fiscal years
beginning after December 15, 2001. We will adopt SFAS No. 142 effective January
1, 2002. We are currently evaluating the effect that adoption of this Statement
will have on our financial position, results of operations and cash flows.
In October 2001, the Financial Accounting Standards Board issued SFAS No.
144, "Accounting for the Impairment or Disposal of Long-Lived Assets," that
develops one accounting model for long-lived assets that are to be disposed of
by sale and expands the scope of discontinued operations. This Statement is
effective for fiscal years beginning after December 15, 2001. We will adopt SFAS
No. 144 effective January 1, 2002 and are currently evaluating the effect that
adoption of this Statement will have on our financial position, results of
operations, and cash flows.
20
RISK FACTORS THAT MAY AFFECT RESULTS OF OPERATIONS AND FINANCIAL CONDITION
The risks and uncertainties described below are not the only ones facing us.
Additional risks and uncertainties not presently known to us or that we
currently deem immaterial also may impair our business operations. If any of the
following risks or such other risks actually occur, our business could be
harmed.
Our operating results may fluctuate
Our operating results have varied on a quarterly basis during our operating
history. Our operating results may fluctuate significantly as a result of a
variety of factors, many of which are outside our control. Factors that may
affect our quarterly operating results include the following:
- our ability to retain an active user base, to attract new users who list
items for sale and who purchase items through our service and to
maintain customer satisfaction;
- our ability to keep our websites operational and to manage the number of
items listed on our service;
- the amount and timing of operating costs and capital expenditures
relating to the maintenance and expansion of our business, operations
and infrastructure;
- foreign, federal, state or local government regulation, including
investigations prompted by items improperly listed or sold by our users;
- the introduction of new sites, services and products by us or our
competitors;
- volume, size, timing and completion rate of trades on our websites;
- consumer willingness to consummate transactions with other users who are
not known to them;
- consumer confidence in the security of transactions on our websites;
- our ability to upgrade and develop our systems and infrastructure to
accommodate growth;
- our ability to successfully integrate and manage our acquisitions,
including our purchase of a majority interest in Internet Auction and
our acquisition of iBazar earlier this year;
- technical difficulties or service interruptions;
- our ability to attract new personnel in a timely and effective manner;
- our ability to retain key employees in both our online businesses and
our acquisitions;
- our ability to expand our product offerings involving fixed price
trading successfully;
- the ability of our land-based auction businesses to acquire high quality
properties for auction;
- the timing, cost and availability of advertising in traditional media
and on other websites and online services;
- the cost and demand for advertising on our own websites;
- the timing of payments to us and of marketing and other expenses under
existing and future contracts;
- consumer trends and popularity of some categories of items;
- the success of our brand building and marketing campaigns;
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- the continued success of our commercial partners and technology
suppliers;
- the level of use of the Internet and online services;
- increasing consumer acceptance of the Internet and other online services
for commerce and, in particular, the trading of products such as those
listed on our websites; and
- general economic conditions and economic conditions specific to the
Internet and e-commerce industries.
Our limited operating history and the increased variety of services offered
on our sites, makes it difficult for us to forecast the level or source of our
revenues or earnings accurately. We believe that period-to-period comparisons of
our operating results may not be meaningful, and you should not rely upon them
as an indication of future performance. We do not have backlog, and a
substantial portion of our net revenues each quarter come from transactions for
items that are listed and sold during that quarter. Our operating results in one
or more future quarters may fall below the expectations of securities analysts
and investors. In that event, the trading price of our common stock would almost
certainly decline.
Impact of September 11 attack
The September 11 terrorist attack adversely affected our revenues and
profits, particularly in the U.S. Any further terrorist actions, whether in the
U.S. or elsewhere, would likely adversely affect our business. In particular,
any action (for example, further bio-terrorism involving letters or packages)
that makes consumers less willing to purchase or receive goods from third
parties they do not know could disproportionately and adversely affect our
business.
We have a limited operating history
Our company was formed as a sole proprietorship in September 1995 and was
incorporated in California in May 1996 and reincorporated in Delaware in April
1998. We have only a limited operating history on which you can base an
evaluation of our business and prospects. As an online commerce company still
relatively early in our development, we face substantial risks, uncertainties,
expenses and difficulties. To address these risks and uncertainties, we and our
subsidiaries must do the following:
- maintain and increase our number of registered users, items listed on
our service and completed sales;
- expand into new categories, geographies, and service areas;
- maintain and grow our websites and customer support operations at a
reasonable cost;
- continue to make trading through our service safer for users;
- maintain and enhance our brand;
- continue to develop and upgrade our technology and information
processing systems;
- continue to enhance and expand our service to meet the changing
requirements of our users;
- provide superior customer service;
- remain attractive to our commercial partners;
- respond to changing legal environments in a variety of countries
- respond to competitive developments; and
- attract, integrate, retain and motivate qualified personnel.
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We may be unable to accomplish one or more of these goals, which could cause
our business to suffer. In addition, accomplishing one or more of these goals
might be very expensive, which could harm our financial results.
We may not maintain profitability
We believe that our continued profitability will depend in large part on our
ability to do the following:
- maintain sufficient transaction volume to attract buyers and sellers;
- manage the costs of our business, including the costs associated with
maintaining and developing our websites, customer support and
international and product expansion;
- increase our brand name awareness; and
- provide our customers with superior community and trading experiences.
We are investing heavily in marketing and promotion, customer support,
further development of our websites, technology and operating infrastructure
development. The costs of these investments are expected to remain significant
into the future. In addition, many of our acquisitions require continuing
investments in these areas and we have significant ongoing contractual
commitments in some of these areas. As a result, we may be unable to adjust our
spending rapidly enough to compensate for any unexpected revenue shortfall,
which may harm our profitability. The existence of several larger and more
established companies that are enabling online sales as well as newer companies,
some of whom do not charge for transactions on their sites and others who are
facilitating trading through other pricing formats (e.g., fixed price, reverse
auction, group buying, etc.) may limit our ability to raise user fees in
response to declines in profitability. In addition, we are spending in advance
of anticipated growth, which may also harm our profitability. In view of the
rapidly evolving nature of our business and our limited operating history, we
believe that period-to-period comparisons of our operating results are not
necessarily meaningful. You should not rely upon our historical results as
indications of our future performance.
Acquisitions could result in dilution, operating difficulties and other harmful
consequences
We have acquired a number of businesses, including our recently completed
acquisitions of Half.com, Internet Auction, iBazar and HomesDirect.com and may
in the future acquire businesses, technologies, services or products that we
believe are strategic. The process of integrating any acquisition may create
unforeseen operating difficulties and expenditures and is itself risky. The
areas where we may face difficulties include:
- diversion of management time (at both companies) during the period of
negotiation through closing and further diversion of such time after
closing, as well as a shift of focus from operating the businesses to
issues of integration and future products;
- declining employee morale and retention issues resulting from changes in
compensation, reporting relationships, future prospects or the direction
of the business;
- the need to integrate each company's accounting, management information,
human resource and other administrative systems to permit effective
management, and the lack of control if such integration is delayed or
not implemented;
- the need to implement controls, procedures and policies appropriate for
a larger public company at companies that prior to acquisition had
lacked such controls, procedures and policies; and
- in some cases, the need to transition operations onto the existing eBay
platform.
Prior to the four acquisitions we made in the second quarter of 1999, we had
almost no experience in managing this integration process. Many of our
acquisitions to date have involved either family-run companies or very early
stage companies, which may worsen these integration issues. Foreign acquisitions
involve special risks, including those related to
23
integration of operations across different cultures, currency risks and the
particular economic and regulatory risks associated with specific countries.
Moreover, the anticipated benefits of any or all of our acquisitions may not be
realized. Future acquisitions or mergers could result in potentially dilutive
issuances of equity securities, the incurrence of debt, contingent liabilities
or amortization expenses related to goodwill and other intangible assets, any of
which could harm our business. Future acquisitions or mergers may require us to
obtain additional equity or debt financing, which may not be available on
favorable terms or at all. Even if available, this financing may be dilutive.
There are many risks associated with our international operations
In 1999, we acquired alando.de.ag, a leading online German personal trading
platform, and began operations in the United Kingdom and, through a joint
venture, in Australia. In the first quarter of 2000, we further expanded into
Japan and formally launched our localized Canadian operations. In October 2000,
we launched our French site. In January 2001, we launched our Italian site. In
February 2001, we completed our acquisition of a majority interest in Internet
Auction, and in May 2001, we completed our acquisition of iBazar, a French
company with online trading operations in eight countries, primarily in Europe.
Expansion into international markets requires management attention and
resources. We have limited experience in localizing our service to conform to
local cultures, standards and policies. In most countries, we will have to
compete with local companies who understand the local market better than we do.
We may not be successful in expanding into international markets or in
generating revenues from foreign operations. Even if we are successful, the
costs of operating new sites are expected to exceed our net revenues for at
least 12 months in most countries. As we continue to expand internationally, we
are subject to risks of doing business internationally, including the following:
- regulatory requirements, including regulation of "auctions," that may
limit or prevent the offering of our services in local jurisdictions,
may prevent enforceable agreements between sellers and buyers, may
prohibit certain categories of goods or may limit the transfer of
information between our foreign subsidiaries and ourselves;
- legal uncertainty regarding liability for the listings of our users,
including less Internet-friendly legal systems, unique local laws and
lack of clear precedent or applicable law;
- difficulties in staffing and managing foreign operations;
- longer payment cycles, different accounting practices and problems in
collecting accounts receivable;
- local taxation of transactions on our websites;
- higher telecommunications and Internet service provider costs;
- stronger local competitors;
- more stringent consumer and data protection laws;
- cultural non-acceptance of online trading;
- seasonal reductions in business activity; and
- potentially adverse tax consequences.
Some of these factors may cause our international costs to exceed our
domestic costs of doing business. To the extent we expand our international
operations and have additional portions of our international revenues
denominated in foreign currencies, we also could become subject to increased
difficulties in collecting accounts receivable and risks relating to foreign
currency exchange rate fluctuations.
Disputes between our Korean subsidiary, Internet Auction, and credit card
companies may harm our operations in Korea
The credit card companies providing payment services to our majority-owned
Korean subsidiary, Internet Auction, have experienced higher than anticipated
delinquency rates on transactions carried out on the Internet Auction platform.
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Some of these delinquencies are related to fictitious transactions on Internet
Auction and other Korean internet sites to enable users to receive cash advances
on their credit cards that would not otherwise be permitted by the credit card
companies. As of September 30, 2001, the credit card companies had withheld
approximately 5.6 billion Won (about $4.3 million) as "collateral" against
certain delinquent accounts, and had threatened to terminate their agreements
with Internet Auction if matters were not resolved to their satisfaction.
Beginning in the Spring of 2001, Internet Auction has been putting into place
certain user verification and site monitoring processes that it believes have
substantially reduced this type of credit card misuse on its system. Internet
Auction is currently in negotiations with the credit card companies to resolve
this situation. If these negotiations are not successful, termination of its
agreements with the credit card companies would adversely affect Internet
Auction's business and could adversely impact eBay's business. Any settlement
related to past transactions could adversely affect Internet Auction's results
of operations but is not expected to be material to eBay's consolidated
financial statements.
Our revenue from third party advertising and end-to-end services and promotions
is subject to factors beyond our control
We are receiving revenues from end-to-end service providers and direct
advertising promotions. These revenues may be affected by the financial
condition of the parties with whom we have these relationships and by the
success of online promotions generally. Recently, the pricing of online
advertisements has deteriorated. Our direct advertising revenue is dependent in
significant part on the performance of AOL's sales force, over which we do not
have control. These revenues have become increasingly important to us. Reduction
in these revenues, whether due to the softening of the demand for online
advertising in general or particular problems facing parties with whom we have
commercial relationships, would adversely affect our results.
Our failure to manage growth could harm us
We currently are experiencing a period of expansion in our headcount,
facilities and infrastructure, and we anticipate that further expansion will be
required to address potential growth in our customer base and number of listings
as well as our expansion into new geographic areas, types of goods and
alternative methods of sale. This expansion has placed, and we expect it will
continue to place, a significant strain on our management, operational and
financial resources. The areas that are put under strain by our growth include
the following:
- The Websites. We must constantly add new hardware, update software and
add new engineering personnel to accommodate the increased use of our
and our subsidiaries' websites and the new products and features we are
regularly introducing. This upgrade process is expensive, and the
increased complexity of our websites increases the cost of additional
enhancements. If we are unable to increase the capacity of our systems
at least as fast as the growth in demand for this capacity, our websites
may become unstable and may cease to operate for periods of time. We
have experienced periodic unscheduled downtime. Continued unscheduled
downtime would harm our business and also could anger users of our
websites and reduce future revenues.
- Customer Support. We are expanding our customer support operations to
accommodate the increased number of users and transactions on our
websites and the increased level of trust and safety activity we provide
worldwide. If we are unable to provide these operations in a
cost-effective manner, users of our websites may have negative
experiences, and current and future revenues could suffer, or our
operating margins may decrease.
- Customer Accounts. Our revenues are dependent on prompt and accurate
billing processes. If we are unable to grow our transaction processing
abilities to accommodate the increasing number of transactions that must
be billed, our ability to collect revenue will be harmed.
We must continue to hire, train and manage new employees at a rapid rate.
The majority of our employees today have been with us less than eighteen months
and we expect that our rate of hiring will continue at a high pace. If our new
hires perform poorly, or if we are unsuccessful in hiring, training, managing
and integrating these new employees, or if we are not successful in retaining
our existing employees, our business may be harmed. To manage the expected
growth of our operations and personnel, we will need to improve our transaction
processing, operational and financial systems, procedures and controls. This is
a special challenge as we acquire new operations with different systems. Our
current and planned personnel, systems, procedures and controls may not be
adequate to support our future operations. We may be unable to hire, train,
retain and manage required personnel or to identify and take advantage of
existing and potential strategic relationships and market opportunities.
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Our business may be harmed by the listing or sale by our users of illegal items
The law relating to the liability of providers of online services for the
activities of their users on their service is currently unsettled. We are aware
that certain goods, such as firearms, other weapons, adult material, tobacco
products, alcohol and other goods that may be subject to regulation by local,
state or federal authorities, have been listed and traded on our service. We may
be unable to prevent the sale of unlawful goods, or the sale of goods in an
unlawful manner, by users of our service, and we may be subject to allegations
of civil or criminal liability for unlawful activities carried out by users
through our service. We have been subject to several lawsuits based upon such
allegations. In order to reduce our exposure to this liability, we have
prohibited the listing of certain items and increased the number of personnel
reviewing questionable items. In the future, we may implement other protective
measures that could require us to spend substantial resources and/or to reduce
revenues by discontinuing certain service offerings. Any costs incurred as a
result of liability or asserted liability relating to the sale of unlawful goods
or the unlawful sale of goods, could harm our business. In addition, we have
received significant and continuing media attention relating to the listing or
sale of unlawful goods on our websites. This negative publicity could damage our
reputation and diminish the value of our brand name. It also could make users
reluctant to continue to use our services.
Our business may be harmed by the listing or sale by our users of pirated or
counterfeit items
We have received in the past, and we anticipate we will receive in the
future, communications alleging that certain items listed or sold through our
service by our users infringe third-party copyrights, trademarks and tradenames
or other intellectual property rights. Although we have sought to work actively
with the content community to eliminate infringing listings on our websites,
some content owners have expressed the view that our efforts are insufficient.
Content owners have been active in defending their rights against online
companies, including eBay. Allegations of infringement of third-party
intellectual property rights have in the past and may in the future result in
litigation against us. Such litigation is costly for us, could result in
increased costs of doing business through adverse judgment or settlement, could
require us to change our business practices in expensive ways, or could
otherwise harm our business. Litigation against other online companies could
result in interpretations of the law that could also require us to change our
business practices or otherwise increase our costs.
Our business may be harmed by fraudulent activities on our websites
Our future success will depend largely upon sellers reliably delivering and
accurately representing their listed goods and buyers paying the agreed purchase
price. We have received in the past, and anticipate that we will receive in the
future, communications from users who did not receive the purchase price or the
goods that were to have been exchanged. In some cases individuals have been
arrested and convicted for fraudulent activities using our websites. While we
can suspend the accounts of users who fail to fulfill their delivery obligations
to other users, we do not have the ability to require users to make payments or
deliver goods or otherwise make users whole other than through our limited
reimbursement program. Other than through this program, we do not compensate
users who believe they have been defrauded by other users. We also periodically
receive complaints from buyers as to the quality of the goods purchased.
Negative publicity generated as a result of fraudulent or deceptive conduct by
users of our service could damage our reputation and diminish the value of our
brand name. We expect to continue to receive requests from users requesting
reimbursement or threatening or commencing legal action against us if no
reimbursement is made. Our liability for these sort of claims is only beginning
to be clarified and may be higher in some non-U.S. jurisdictions than it is in
the U.S. This sort of litigation could be costly for us, divert management
attention, result in increased costs of doing business, lead to adverse
judgments or could otherwise harm our business. In addition, affected users will
likely complain to regulatory agencies who could take action against us,
including imposing fines or seeking injunctions.
Government inquiries may lead to charges or penalties
On January 29, 1999, we received initial requests to produce certain records
and information to the federal government relating to an investigation of
possible illegal transactions in connection with our websites. We were informed
that the inquiry includes an examination of our practices with respect to these
transactions. We have continued to provide further information in connection
with this ongoing inquiry. In order to protect the investigation, the court has
ordered that no further public disclosures be made with respect to the matter.
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On March 24, 2000, Butterfields received a grand jury subpoena from the
Antitrust Division of the Department of Justice requesting documents relating
to, among other things, changes in Butterfields' seller commissions and buyer
premiums and discussions, agreements or understandings with other auction
houses, in each case since 1992. We believe this request may be related to a
publicly reported criminal case against certain auction houses for price fixing.
We have provided the information requested in the subpoena.
Should these or any other investigations lead to civil or criminal charges
against us, we would likely be harmed by negative publicity, the costs of
litigation, the diversion of management time and other negative effects, even if
we ultimately prevail. Our business would suffer if we were not to prevail in
any actions like these. Even the process of providing records and information
can be expensive, time consuming and result in the diversion of management
attention.
A large number of transactions occur on our websites. We believe that
government regulators have received a substantial number of consumer complaints
about us which, while small as a percentage of our total transactions, are large
in aggregate numbers. As a result, we have from time to time been contacted by
various foreign, federal, state and local regulatory agencies and been told that
they have questions with respect to the adequacy of the steps we take to protect
our users from fraud. We are likely to receive additional inquiries from
regulatory agencies in the future, which may lead to action against us. We have
responded to all inquiries from regulatory agencies by describing our current
and planned antifraud efforts. If one or more of these agencies is not satisfied
with our response to current or future inquiries, the resultant investigations
and potential fines or other penalties could harm our business.
We are subject to laws relating to the use and transfer of personally
identifiable information about our users and their transfers, especially outside
of the U.S. Violation of these laws, which in many cases apply not only to
third-party transfers but also to transfers of information between ourselves and
our subsidiaries, and between ourselves, our subsidiaries and our commercial
partners could subject us to significant penalties and negative publicity and
could adversely affect our company.
Third parties or governmental agencies may view our behavior as anti-competitive
Third parties have in the past and may in the future allege that actions
taken by us violate the antitrust or competition laws of the U.S or other
countries, or otherwise constitute unfair competition. Such claims typically are
very expensive to defend, involve negative publicity and diversion of management
time and effort and could result in significant judgments against us, all of
which would adversely affect us.
We have provided information to the antitrust division of the Department of
Justice in connection with an inquiry into our conduct with respect to "auction
aggregators" including our licensing program and a previously settled lawsuit
against Bidder's Edge. Should the division decide to take action against us, or
should the Department of Justice or any other antitrust agency open other
investigations of our activities, we would likely be harmed by negative
publicity, the costs of the action, possible private antitrust lawsuits, the
diversion of management time and effort and penalties we might suffer if we
ultimately were not to prevail.
Some of our businesses are subject to regulation and others may be in the future
Both Butterfields and Kruse are subject to regulation in some jurisdictions
governing the manner in which live auctions are conducted. Both are required to
obtain licenses in these jurisdictions with respect to their business or to
permit the sale of categories of items (e.g., wine, automobiles and real
estate). These licenses generally must be renewed regularly and are subject to
revocation for violation of law, violation of the regulations governing auctions
in general or the sale of the particular item and other events. If either
company was unable to renew a license or had a license revoked, its business
would be harmed. In addition, changes to the regulations or the licensure
requirements could increase the complexity and the cost of doing auctions,
thereby harming us.
As our activities and the types of goods listed on our site expand, state
regulatory agencies may claim that we are subject to licensure in their
jurisdiction, either with respect to our services in general, or in order to
sell certain types of goods (e.g., real estate, boats, automobiles, etc.). These
claims could result in costly litigation or could require us to change our
manner of doing business in ways that increase our costs or reduce our revenues
or force us to prohibit listings of certain items. We could also be subject to
fines or other penalties. Any of these outcomes could harm our business.
27
As we have expanded internationally, we have become subject to additional
regulations, including regulations on the transmission of personal information.
These laws may require costly changes to our business practices. If we are found
to have violated any of these laws, we could be subject to fines or penalties,
and our business could be harmed.
Our business may be subject to sales and other taxes
We do not collect sales or other similar taxes on goods or services sold by
users through our service. One or more states or any foreign country may seek to
impose sales or use tax collection or record keeping obligations on companies
such as ours that engage in or facilitate online commerce. Several proposals
have been made at the state and local level that would impose additional taxes
on the sale of goods and services through the Internet. These proposals, if
adopted, could substantially impair the growth of e-commerce, and could diminish
our opportunity to derive financial benefit from our activities. In 1998, the
U.S. federal government enacted legislation prohibiting states or other local
authorities from imposing new taxes on Internet commerce for a period of three
years. This tax moratorium ended on October 21, 2001. Unless Congress enacts new
moratorium legislation, states may now enact new discriminatory internet taxes
on our business, which could adversely affect us. Even if a moratorium is
reenacted, it would not prohibit states or the Internal Revenue Service from
collecting taxes on our income, if any, or from collecting taxes that are due
under existing tax rules. A successful assertion by one or more states or any
foreign country that we should collect sales or other taxes on the exchange of
merchandise on our system would harm our business.
Companies that handle payments, including our subsidiaries Billpoint, Half.com
and Internet Auction, may be subject to additional regulation
The Half.com business model involves the handling of payments by buyers for
the items listed by Half.com's sellers. Internet Auction also has a business
model involving the handling of payments by buyers. Billpoint handles its
customer funds as a provider of Internet payment solutions. Businesses that
handle consumers' funds are subject to numerous regulations, including those
related to banking, credit cards, escrow, fair credit reporting, privacy of
financial records and others. Billpoint is a new business with a relatively
novel approach to facilitating payments. It is not yet known how regulatory
agencies will treat Billpoint. The cost and complexity of Billpoint's business
may increase if certain regulations are deemed to apply to its business. In
addition to the need to comply with these regulations, Billpoint's business is
also subject to risks of fraud, the need to grow systems and processes rapidly
if its products are well received, a high level of competition, including larger
and better financed competitors and the need to coordinate systems and policies
among itself, us and Wells Fargo Bank, which is Billpoint's backend provider of
payment services. Similarly, Half.com may be subject to certain regulations
regarding payments and the cost and complexity of its business may increase if
these regulations are deemed to apply to its business.
We are subject to risks associated with information disseminated through our
service
The law relating to the liability of online services companies for
information carried on or disseminated through their services is currently
unsettled. Claims could be made against online services companies under both
U.S. and foreign law for defamation, libel, invasion of privacy, negligence,
copyright or trademark infringement, or other theories based on the nature and
content of the materials disseminated through their services. Several private
lawsuits seeking to impose liability upon us under a number of these theories
have been brought against us. In addition, federal, state and foreign
legislation has been proposed that imposes liability for or prohibits the
transmission over the Internet of certain types of information. Our service
features a Feedback Forum, which includes information from users regarding other
users. Although all such feedback is generated by users and not by us, it is
possible that a claim of defamation or other injury could be made against us for
content posted in the Feedback Forum. Claims like these are more likely and have
a higher probability of success in jurisdictions outside the U.S. If we become
liable for information provided by our users and carried on our service in any
jurisdiction in which we operate, we could be directly harmed and we may be
forced to implement new measures to reduce our exposure to this liability. This
may require us to expend substantial resources and/or to discontinue certain
service offerings, which would negatively affect our financial results. In
addition, the increased attention focused upon liability issues as a result of
these lawsuits and legislative proposals could harm our reputation or otherwise
impact the growth of our business. Any costs incurred as a result of this
liability or asserted liability could harm our business.
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We are subject to intellectual property and other litigation
On April 25, 2000, we were served with a lawsuit, Gentry et.al. v. eBay,
Inc. et.al, filed in Superior Court in San Diego, California. The lawsuit was
filed on behalf of a purported class of eBay users who purchased allegedly
forged autographed sports memorabilia on eBay. The lawsuit claims we were
negligent in permitting certain named (and other unnamed) defendants to sell
allegedly forged autographed sports memorabilia on eBay. In addition, the
lawsuit claims we violated California unfair competition law and a section of
the California Civil Code which prohibits "dealers" from selling sports
memorabilia without a "Certificate of Authenticity." On January 26, 2001, the
court issued a ruling dismissing all claims against us in the lawsuit. The court
ruled that our business falls within the safe harbor provisions of 47 USC 230,
which grants Internet service providers such as eBay with immunity from state
claims based on the conduct of third parties. The court also noted that we were
not a "dealer" under California law and thus not required to provide
certificates of authenticity with autographs sold over our site by third
parties. All counts of the plaintiffs' suit were dismissed with prejudice as to
eBay. The plaintiffs have appealed this ruling. We believe we have meritorious
defenses and intend to defend ourselves vigorously.
On April 25, 2001, our European subsidiaries, eBay GmbH and eBay
International AG, were sued by Montres Rolex S.A. and certain Rolex affiliates
("Rolex") in the regional court of Cologne, Germany. Rolex alleged that our
subsidiaries were infringing Rolex's trademarks as result of users selling
counterfeit Rolex watches through our German website. The suit also alleges
unfair competition. Rolex is seeking an order forbidding the sale of Rolex
watches on the website as well as damages. We believe that we have meritorious
defenses against this claim and intend to defend ourselves vigorously.
Other third parties have from time to time claimed, and others may claim in
the future that we have infringed their past, current or future intellectual
property rights. We have in the past been forced to litigate such claims. We may
become more vulnerable to such claims as laws such as the Digital Millennium
Copyright Act are interpreted by the courts and as we expand into jurisdictions
where the underlying laws with respect to the potential liability of online
intermediaries like ourselves is less favorable. We expect that we will
increasingly be subject to infringement claims as the geographical reach of our
services expands. These claims, whether meritorious or not, could be
time-consuming, result in costly litigation, cause service upgrade delays,
require expensive changes in our methods of doing business or could require us
to enter into costly royalty or licensing agreements, if available. As a result,
these claims could harm our business.
On September 26, 2001 a complaint was filed by MercExchange LLC against us,
our Half.com subsidiary and ReturnBuy, Inc. in the Eastern District of Virginia
(No. 2:01-CV-736) alleging infringement of three patents and seeking a permanent
injunction and damages (including treble damages for willful infringement). We
have answered this complaint, denying the allegations, and we believe we have
meritorious defenses and will defend ourselves vigorously. However, even if
successful, our defense against this action could be costly and divert our
management's time. If the plaintiff was to prevail on all of its claims, we
might be forced to pay significant damages and licensing fees, modify our
business practices or even be enjoined from practicing a significant part of our
U.S. business. Any such results could materially harm our business.
From time to time, we are involved in other disputes that arise in the
ordinary course of business. We believe that the ultimate resolution of these
other disputes will not have a material adverse impact on our financial
position, results of operations, or cash flows.
The inability to expand our systems may limit our growth
We seek to generate a high volume of traffic and transactions on our
service. The satisfactory performance, reliability and availability of our
websites, processing systems and network infrastructure are critical to our
reputation and our ability to attract and retain large numbers of users. Our
revenues depend primarily on the number of items listed by users, the volume of
user transactions that are successfully completed and the final prices paid for
the items listed. We need to expand and upgrade our technology, transaction
processing systems and network infrastructure both to meet increased traffic on
our site and to implement new features and functions, including those required
under our contracts with third parties. We may be unable to accurately project
the rate or timing of increases, if any, in the use of our service or to expand
and upgrade our systems and infrastructure to accommodate any increases in a
timely fashion.
We use internally developed systems to operate our service for transaction
processing, including billing and collections processing. We must continually
improve these systems in order to accommodate the level of use of our websites.
In addition, we may add new features and functionality to our services that
would result in the need to develop or license
29
additional technologies. We capitalize hardware and software costs associated
with this development in accordance with generally accepted accounting
principles and include such amounts in property and equipment. Our inability to
add additional software and hardware or to upgrade our technology, transaction
processing systems or network infrastructure to accommodate increased traffic or
transaction volume could have adverse consequences. These consequences include
unanticipated system disruptions, slower response times, degradation in levels
of customer support, impaired quality of the users' experiences of our service
and delays in reporting accurate financial information. Our failure to provide
new features or functionality also could result in these consequences. We may be
unable to effectively upgrade and expand our systems in a timely manner or to
integrate smoothly any newly developed or purchased technologies with our
existing systems. These difficulties could harm or limit our ability to expand
our business.
Unauthorized break-ins or other assaults on our service could harm our business
Our servers are vulnerable to computer viruses, physical or electronic
break-ins and similar disruptions, which could lead to interruptions, delays,
loss of data, public release of confidential data or the inability to complete
customer transactions. In addition, unauthorized persons may improperly access
our data. We have experienced an unauthorized break-in by a "hacker" who has
stated that he could, in the future, damage or change our system or take
confidential information. We have also experienced "denial of service" type
attacks on our system that have made all or portions of our websites unavailable
for periods of time. These and other types of attacks could harm us. Actions of
this sort may be very expensive to remedy and could damage our reputation and
discourage new and existing users from using our service.
System failures could harm our business
Substantially all of our computer hardware for operating our services (other
than Half.com) currently is located at the facilities of Exodus Communications,
Inc. in Santa Clara, California and AboveNet Communications, Inc. in San Jose,
California. The computer hardware for the Half.com service is located in the
facilities of Level 3 Communications, Inc. in Philadelphia, Pennsylvania. These
systems and operations are vulnerable to damage or interruption from
earthquakes, floods, fires, power loss, telecommunication failures and similar
events. They are also subject to break-ins, sabotage, intentional acts of
vandalism and to potential disruption if the operators of these facilities have
financial difficulties. Exodus has filed for Chapter 11 protection under the
bankruptcy laws, although it is continuing to provide hosting services to us. We
do not maintain fully redundant systems or alternative providers of hosting
services, and we do not carry business interruption insurance sufficient to
compensate us for losses that may occur. Despite any precautions we may take,
the occurrence of a natural disaster, a decision to close a facility we are
using without adequate notice for financial reasons or other unanticipated
problems at any of the Exodus, AboveNet or Level 3 facilities could result in
lengthy interruptions in our services. In addition, the failure by Exodus,
AboveNet or Level 3 to provide our required data communications capacity could
result in interruptions in our service. Any damage to or failure of our systems
could result in interruptions in our service. Interruptions in our service will
reduce our revenues and profits, and our future revenues and profits will be
harmed if our users believe that our system is unreliable.
We have experienced system failures from time to time. Our primary website
has been interrupted for periods of up to 22 hours. In addition to placing
increased burdens on our engineering staff, these outages create a flood of user
questions and complaints that need to be addressed by our customer support
personnel. Any unscheduled interruption in our service results in an immediate
loss of revenues that can be substantial and may cause some users to switch to
our competitors. If we experience frequent or persistent system failures, our
reputation and brand could be permanently harmed. We have been taking steps to
increase the reliability and redundancy of our system. These steps are
expensive, reduce our margins and may not be successful in reducing the
frequency or duration of unscheduled downtime.
Our stock price has been and may continue to be extremely volatile
The trading price of our common stock has been and is likely to be extremely
volatile. Our stock price could be subject to wide fluctuations in response to a
variety of factors, including the following:
- actual or anticipated variations in our quarterly operating results;
- unscheduled system downtime;
- additions or departures of key personnel;
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- announcements of technological innovations or new services by us or our
competitors;
- changes in financial estimates by securities analysts;
- conditions or trends in the Internet and online commerce industries;
- changes in the market valuations of other Internet companies;
- developments in Internet regulation;
- announcements by us or our competitors of significant acquisitions,
strategic partnerships, joint ventures or capital commitments;
- unanticipated economic or political events;
- sales of our common stock or other securities in the open market; and
- other events or factors, including these described in this "Risk
Factors" section and others that may be beyond our control.
In addition, the trading price of Internet stocks in general, and ours in
particular, have experienced extreme price and volume fluctuations in recent
periods. These fluctuations often have been unrelated or disproportionate to the
operating performance of these companies. Notwithstanding a sharp decline in the
prices of Internet stocks in general, the valuation of our stock remains
extraordinarily high based on conventional valuation standards such as
price-to-earnings and price-to-sales ratios. The trading price of our common
stock has increased enormously from the initial public offering price. This
trading price and valuation may not be sustained. Negative changes in the
public's perception of the prospects of Internet or e-commerce companies have in
the past and may in future depress our stock price regardless of our results.
Other broad market and industry factors may decrease the market price of our
common stock, regardless of our operating performance. Market fluctuations, as
well as general political and economic conditions, such as recession or interest
rate or currency rate fluctuations, also may decrease the market price of our
common stock. In the past, following declines in the market price of a company's
securities, securities class-action litigation often has been instituted.
Litigation of this type, if instituted, could result in substantial costs and a
diversion of management's attention and resources.
New and existing regulations could harm our business
We are subject to the same foreign, federal, state and local laws as other
companies conducting business on the Internet. Today there are relatively few
laws specifically directed towards online services. However, due to the
increasing popularity and use of the Internet and online services, many laws
relating to the Internet are being debated at the state and federal levels (both
in the U.S. and abroad) and it is possible that laws and regulations will be
adopted with respect to the Internet or online services. These laws and
regulations could cover issues such as user privacy, freedom of expression,
pricing, fraud, content and quality of products and services, taxation,
advertising, intellectual property rights and information security.
Applicability to the Internet of existing laws governing issues such as property
ownership, copyrights and other intellectual property issues, taxation, libel,
obscenity and personal privacy is uncertain. The vast majority of these laws was
adopted prior to the advent of the Internet and related technologies and, as a
result, do not contemplate or address the unique issues of the Internet and
related technologies. Those laws that do reference the Internet, such as the
Digital Millennium Copyright Act and the European Union's Directive on Distance
Selling, are only beginning to be interpreted by the courts and their
applicability and scope are, therefore, uncertain. In addition, numerous states
and foreign jurisdictions, including the State of California, where our
headquarters is located, have regulations regarding how "auctions" may be
conducted and the liability of "auctioneers" in conducting such auctions. No
final legal determination has been made with respect to the applicability of the
California regulations to our business to date and little precedent exists in
this area. Several states are considering imposing these regulations upon us or
our users, which could harm our business. In addition, as the nature of the
products listed by our users change, we may become subject to new regulatory
restrictions.
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Several states have proposed legislation that would limit the uses of
personal user information gathered online or require online services to
establish privacy policies. The Federal Trade Commission also has settled
several proceedings regarding the manner in which personal information is
collected from users and provided to third parties. Specific statutes intended
to protect user privacy have been passed in many non-U.S. jurisdictions,
including virtually every non-U.S. jurisdiction in which we currently have a
website. Compliance with these laws, given the tight integration of our systems
across different countries and the need to move data to facilitate transactions
amongst our users (e.g., to payment companies, shipping companies, etc.) is both
necessary and difficult. Failure to comply could subject us to lawsuits, fines,
statutory damages, adverse publicity and other losses that could harm our
business. Changes to existing laws or the passage of new laws intended to
address these issues could directly affect the way we do business or could
create uncertainty on the Internet. This could reduce demand for our services,
increase the cost of doing business as a result of litigation costs or increased
service delivery costs, or otherwise harm our business. In addition, because our
services are accessible worldwide, and we facilitate sales of goods to users
worldwide, foreign jurisdictions may claim that we are required to comply with
their laws. For example, a French court has recently ruled that a U.S. website
must comply with French laws regarding content. As we have expanded our
international activities, we have become obligated to comply with the laws of
the countries in which we operate. Laws regulating Internet companies outside of
the U.S. may be less favorable than those in the U.S., giving greater rights to
consumers, content owners and users. Compliance may be more costly or may
require us to change our business practices or restrict our service offerings
relative to those in the U.S. Our failure to comply with foreign laws could
subject us to penalties ranging from fines to bans on our ability to offer our
services.
Our business has been seasonal
Our results of operations historically have been somewhat seasonal in nature
because many of our users reduce their activities on our websites during the
Thanksgiving and Christmas holidays and with the onset of good weather. We have
historically experienced our strongest quarter of online growth in our first
fiscal quarter, although our shift to more "practical" items may cause our
seasonal patterns to look more like a typical retailer. Both Butterfields and
Kruse have significant quarter-to-quarter variations in their results of
operations depending on the timing of auctions and the availability of high
quality items from large collections and estates. Butterfields typically has its
best operating results in the traditional fall and spring auction seasons and
has historically incurred operating losses in the first and third quarters.
Kruse typically sees a seasonal peak in operations in the third quarter.
Seasonal or cyclical variations in our business may become more pronounced over
time and may harm our results of operations in the future.
We are dependent on the continued growth of online commerce
The business of selling goods over the Internet, particularly through
personal trading, is new and dynamic. Our future net revenues and profits will
be substantially dependent upon the widespread acceptance of the Internet and
online services as a medium for commerce by consumers. Rapid growth in the use
of and interest in the Internet and online services is a recent phenomenon. This
acceptance and use may not continue. Even if the Internet is accepted, concerns
about fraud, privacy and other problems may mean that a sufficiently broad base
of consumers will not adopt the Internet as a medium of commerce. In particular,
our websites require users to make publicly available personal information that
some potential users may be unwilling to provide. These concerns may increase as
additional publicity over privacy issues on eBay or generally over the Internet
increase. Market acceptance for recently introduced services and products over
the Internet is highly uncertain, and there are few proven services and
products. In order to expand our user base, we must appeal to and acquire
consumers who historically have used traditional means of commerce to purchase
goods. If these consumers prove to be less active than our earlier users, and we
are unable to gain efficiencies in our operating costs, including our cost of
acquiring new customers, our business could be adversely impacted.
We are dependent on key personnel
Our future performance will be substantially dependent on the continued
services of our senior management and other key personnel. Our future
performance also will depend on our ability to retain and motivate our other
officers and key personnel. The loss of the services of any of our executive
officers or other key employees could harm our business. We do not have
long-term employment agreements with any of our key personnel, we do not
maintain any "key person" life insurance policies and many of our senior
officers will fully vest the majority of their equity incentives within the next
twelve months. Our new businesses are all dependent on attracting and retaining
key personnel. The land-based auction businesses are particularly dependent on
specialists and senior management because of the relationships these individuals
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have established with sellers who consign property for sale at auction. We have
had some turnover of these personnel, and continued losses of these individuals
could result in the loss of significant future business and would harm us. In
addition, employee turnover and other labor problems frequently increases during
the period following an acquisition as employees evaluate possible changes in
compensation, culture, reporting relationships and the direction of the
business. These labor issues may be more severe if employees receive no
significant financial return from the acquisition transaction, as has been the
case with several of our recent acquisitions. Such increased turnover could
increase our costs and reduce our future revenues. Our future success also will
depend on our ability to attract, train, retain and motivate highly skilled
technical, managerial, marketing and customer support personnel. Competition for
these personnel is intense, especially for engineers and other professionals,
especially in the San Francisco Bay Area, and we may be unable to successfully
attract, integrate or retain sufficiently qualified personnel. In making
employment decisions, particularly in the Internet and high-technology
industries, job candidates often consider the value of the stock options they
are to receive in connection with their employment. Fluctuations in our stock
price may make it more difficult to retain and motivate employees whose stock
option strike prices are substantially above current market prices.
California power outages could adversely affect us
The State of California is currently experiencing a chronic shortage of
power and, as a result, power outages may occur. Although we have emergency
backup power capabilities at the facilities of Exodus, AboveNet and Level 3, and
limited backup power at our headquarters, repeated or lengthy power outages may
adversely affect our business.
Our offline auction businesses need to continue to acquire auction properties
The businesses of Butterfields and Kruse are dependent on the continued
acquisition of high quality auction properties from sellers. Their future
success will depend in part on their ability to maintain an adequate supply of
high quality auction property, particularly fine and decorative arts and
collectibles and collectible automobiles, respectively. There is intense
competition for these pieces with other auction companies and dealers. In
addition, a small number of key senior management and specialists maintain the
relationships with the primary sources of auction property and the loss of these
individuals could harm the businesses of Butterfields and Kruse.
Our offline auction businesses could suffer losses from price guarantees,
advances or rescissions of sales
In order to secure high quality auction properties from sellers,
Butterfields and Kruse may give a guaranteed minimum price or a cash advance to
a seller, based on the estimated value of the property. If the auction proceeds
are less than the amount guaranteed, or less than the amount advanced and the
seller does not repay the difference, the company involved will suffer a loss.
In addition, under certain circumstances a buyer who believes that an item
purchased at auction does not have good title, provenance or authenticity may
rescind the purchase. Under these circumstances, the company involved will lose
its commissions and fees on the sale even if the seller, in accordance with the
terms and conditions of sale, in turn accepts back the item and returns the
funds he or she received from the sale.
We are subject to the risks of owning real property
In connection with the acquisitions of Kruse and Butterfields, we acquired
real property including land, buildings and interests in partnerships holding
land and buildings. We have no experience in managing real property. Ownership
of this property subjects us to new risks, including:
- the possibility of environmental contamination and the costs associated
with fixing any environmental problems;
- adverse changes in the value of these properties, due to interest rate
changes, changes in the neighborhoods in which the properties are
located, or other factors;
- the possible need for structural improvements in order to comply with
zoning, seismic, disability act or other requirements; and
- possible disputes with tenants, partners or others.
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Our market is intensely competitive
Depending on the category of product, we currently or potentially compete
with a number of companies serving particular categories of goods as well as
those serving broader ranges of goods. The Internet is a new, rapidly evolving
and intensely competitive area. We expect competition to intensify in the future
as the barriers to entry are relatively low, and current and new competitors can
launch new sites at a nominal cost using commercially available software. Our
broad-based competitors include the vast majority of traditional department and
general merchandise stores as well as emerging online retailers. These include
most prominently: Wal-Mart, Kmart, Target, Sears, Macy's, JC Penney, Costco,
Office Depot, Staples, OfficeMax and Sam's Club as well as Amazon.com, Buy.com,
AOL.com, Yahoo! shopping and MSN.
In addition, we face competition from local, regional and national specialty
retailers and exchanges in each of its categories of products. For example:
Antiques: Christie's, eHammer, Sotheby's / Sothebys.com, Phillips (LVMH)
Coins & Stamps: Collectors Universe, Heritage, US Mint, Bowers and Morena
Collectibles: Franklin Mint, Go Collect, Collectiblestoday.com,
wizardworld.com, Russ Cochran Comic Art Auctions, All Star Auctions
Musical Instruments: Guitar Center, Sam Ash, Mars Music, Gbase.com,
Harmony-Central.com
Sports Memorabilia: Beckett's, Collectors Universe, Mastro, Leylands,
ThePit.com, Superior
Toys, Bean Bag Plush: Amazon.com, KB Toys, ZanyBrainy.com, Wal-Mart.com
Premium Collectibles: Christies, DuPont Registry, Greg Manning Auctions,
iCollector, Lycos / Skinner Auctions, Millionaire.com, Phillips (LVMH),
Sotheby's, Sothebys.com
Automotive (used cars): Autobytel.com, AutoVantage.com, AutoWeb.com,
Barrett-Jackson, CarPoint, Collectorcartraderonline.com, eClassics.com, Edmunds,
CarsDirect.com, Hemmings, imotors.com, vehix.com, newspaper classifieds, used
car dealers
Books, Movies, Music: Amazon.com, Barnes & Noble, Barnesandnoble.com,
Alibris.com, Blockbuster, BMG, Columbia House, Best Buy, CDNow, Express.com,
Emusic.com
Clothing: Bluefly.com, Dockers.com, FashionMall.com, The Gap, J. Crew,
LandsEnd.com, The Limited, Macy's, The Men's Wearhouse, Ross
Computers & Consumer Electronics: Best Buy, Buy.com, Circuit City, Compaq,
CompUSA, Dell, Fry's Electronics, Gateway, The Good Guys, MicroWarehouse,
Shopping.com, 800.com, Computer Discount Warehouse, PC Connection, computer and
consumer electronics retailers
Home & Garden: IKEA, Crate & Barrel, Home Depot, Pottery Barn, Ethan Allen,
Frontgate, Burpee.com
Jewelry: Ashford.com, Mondera.com
Pottery & Glass: Just Glass, Pottery Auction, Go Collect
Sporting Goods/Equipment: dsports.com, FogDog.com, Footlocker, Gear.com,
golfclubexchange, MVP.com, PlanetOutdoors.com, Play It Again Sports, REI, Sports
Authority, Sportsline.com
Tickets: Ticketmaster, Tickets.com
Tool/Equipment/Hardware: Home Depot, HomeBase, Amazon.com, Ace Hardware,
OSH
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Business-to-Business: Ariba, BidFreight.com, Bid4Assets, BizBuyer.com,
bLiquid.com, Buyer Zone, CloseOutNow.com, Commerce One, Concur Technologies,
DoveBid, FreeMarkets, Iron Planet, labx.com, Oracle, Overstock.com,
PurchasePro.com, RicardoBiz.com, Sabre, SurplusBin.com, Ventro, VerticalNet
Additionally, we face competition from various online auction sites
including: Amazon.com, Surplus Auction, uBid, Yahoo! Auctions and a large number
of other companies using an auction format for consumer-to-consumer or
business-to-consumer sales. Overseas, we face competition from Yahoo! Auctions
in most countries and from a large number of regional and national competitors
in each country. Different aspects of our fixed priced business compete with the
major internet portals (AOL, MSN, Yahoo and comparable companies outside the
U.S.) as well as Amazon.com and others.
The principal competitive factors for eBay include the following:
- ability to attract buyers;
- volume of transactions and selection of goods;
- customer service; and
- brand recognition.
With respect to our online competition, additional competitive factors
include:
- community cohesion and interaction;
- system reliability;
- reliability of delivery and payment;
- website convenience and accessibility;
- level of service fees; and
- quality of search tools.
Some current and potential competitors have longer company operating
histories, larger customer bases and greater brand recognition in other business
and Internet spaces than we do. Some of these competitors also have
significantly greater financial, marketing, technical and other resources. Other
online trading services may be acquired by, receive investments from or enter
into other commercial relationships with larger, well-established and
well-financed companies. As a result, some of our competitors with other revenue
sources may be able to devote more resources to marketing and promotional
campaigns, adopt more aggressive pricing policies and devote substantially more
resources to website and systems development than we can. Increased competition
may result in reduced operating margins, loss of market share and diminished
value of our brand. Some of our competitors have offered services for free, and
others may do this as well. We may be unable to compete successfully against
current and future competitors.
In order to respond to changes in the competitive environment, we may, from
time to time, make pricing, service or marketing decisions or acquisitions that
could harm our business. For example, we have implemented an insurance program
that generally insures items up to a value of $200, with a $25 deductible, for
users with a non-negative feedback rating at no cost to the user. New
technologies may increase the competitive pressures by enabling our competitors
to offer a lower cost service. Some Internet-based applications that direct
Internet traffic to certain websites may channel users to trading services that
compete with us.
Although we have established Internet traffic arrangements with several
large online services and search engine companies, these arrangements may not be
renewed on commercially reasonable terms. Even if these arrangements are
renewed, they may not result in increased usage of our service. In addition,
companies that control access to transactions through network access or Internet
browsers could promote our competitors or charge us substantial fees for
inclusion.
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The offline auction business is intensely competitive. Butterfields competes
with two larger and better known auction companies, Sotheby's Holdings, Inc. and
Christie's International plc, as well as numerous regional auction companies. To
the extent that these companies increase their focus on the middle market
properties that form the core of Butterfields' business or in the western U.S.,
its business may suffer. Kruse is subject to competition from numerous regional
competitors. In addition, competition with Internet-based auctions may harm the
land-based auction business. Although Billpoint's business is new, several new
companies have entered this space, including competitors who are offering free
services and significant promotional incentives, and large companies, including
banks and credit card companies, are also beginning to enter this space.
Half.com competes directly with online retailers in its product categories such
as Amazon.com, which offers a directly competitive service, as well as with
traditional sellers of used books, videos and CDs, consumer electronics,
sporting goods and other products.
Our business is dependent on the development and maintenance of the Internet
infrastructure
The success of our service will depend largely on the development and
maintenance of the Internet infrastructure. This includes maintenance of a
reliable network backbone with the necessary speed, data capacity and security,
as well as timely development of complementary products, for providing reliable
Internet access and services. The Internet has experienced, and is likely to
continue to experience, significant growth in the numbers of users and amount of
traffic. If the Internet continues to experience increased numbers of users,
increased frequency of use or increased bandwidth requirements, the Internet
infrastructure may be unable to support the demands placed on it. In addition,
the performance of the Internet may be harmed by increased number of users or
bandwidth requirements or by "viruses", "worms" and similar programs. The
Internet has experienced a variety of outages and other delays as a result of
damage to portions of its infrastructure, and it could face outages and delays
in the future. These outages and delays could reduce the level of Internet usage
as well as the level of traffic and the processing transactions on our service.
Our business is subject to online commerce security risks
A significant barrier to online commerce and communications is the secure
transmission of confidential information over public networks. Our security
measures may not prevent security breaches. Our failure to prevent security
breaches could harm our business. Currently, a significant number of our users
authorize us to bill their credit card accounts directly for all transaction
fees charged by us. Billpoint's users routinely provide credit card and other
financial information. We rely on encryption and authentication technology
licensed from third parties to provide the security and authentication
technology to effect secure transmission of confidential information, including
customer credit card numbers. Advances in computer capabilities, new discoveries
in the field of cryptography or other developments may result in a compromise or
breach of the technology used by us to protect customer transaction data. A
number of websites have reported breaches of their security. Any compromise of
our security could harm our reputation and, therefore, our business. In
addition, a party who is able to circumvent our security measures could
misappropriate proprietary information or cause interruptions in our operations.
We may need to expend significant resources to protect against security breaches
or to address problems caused by breaches. These issues are likely to become
more difficult as we expand the number of places where we operate. Security
breaches could damage our reputation and expose us to a risk of loss or
litigation and possible liability. Our insurance policies carry low coverage
limits, which may not be adequate to reimburse us for losses caused by security
breaches.
We must keep pace with rapid technological change to remain competitive
Our competitive space is characterized by rapidly changing technology,
evolving industry standards, frequent new service and product introductions and
enhancements and changing customer demands. These characteristics are worsened
by the emerging and changing nature of the Internet. Our future success
therefore will depend on our ability to adapt to rapidly changing technologies,
to adapt our services to evolving industry standards and to improve the
performance, features and reliability of our service. Our failure to adapt to
such changes would harm our business. New technologies, such as the development
of a peer-to-peer personal trading technology, could adversely affect us. In
addition, the widespread adoption of new Internet, networking or
telecommunications technologies or other technological changes could require
substantial expenditures to modify or adapt our services or infrastructure.
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We need to develop new services, features and functions in order to expand
We plan to expand our operations by developing new or complementary
services, products or transaction formats or expanding the breadth and depth of
services. We may be unable to expand our operations in a cost-effective or
timely manner. Even if we do expand, we may not maintain or increase our overall
acceptance. If we launch a new business or service that is not favorably
received by consumers, it could damage our reputation and diminish the value of
our brand. We anticipate that future services will include pre-trade and
post-trade services.
We are pursuing strategic relationships with third parties to provide many
of these services. Because we use third parties to deliver these services, we
may be unable to control the quality of these services, and our ability to
address problems if any of these third parties fails to perform adequately will
be reduced. Expanding our operations in this manner also will require
significant additional expenses and development, operations and other resources
and will strain our management, financial and operational resources. The lack of
acceptance of any new services could harm our business.
Our growth will depend on our ability to develop our brand
We believe that our historical growth has been largely attributable to word
of mouth. We have benefited from frequent and high visibility media exposure
both nationally and locally. We believe that continuing to strengthen our brand
will be critical to achieving widespread acceptance of our service. Promoting
and positioning our brand will depend largely on the success of our marketing
efforts and our ability to provide high quality services. In order to promote
our brand, we will need to increase our marketing budget and otherwise increase
our financial commitment to creating and maintaining brand loyalty among users.
Brand promotion activities may not yield increased revenues, and even if they
do, any increased revenues may not offset the expenses we incurred in building
our brand. If we do attract new users to our service, they may not conduct
transactions over our service on a regular basis. If we fail to promote and
maintain our brand or incur substantial expenses in an unsuccessful attempt to
promote and maintain our brand, our business would be harmed.
We may be unable to protect or enforce our own intellectual property rights
adequately
We regard the protection of our URLs, copyrights, service marks, trademarks,
trade dress and trade secrets as critical to our success. We rely on a
combination of patent, copyright, trademark, service mark and trade secret laws
and contractual restrictions to protect our proprietary rights in products and
services. We have entered into confidentiality and invention assignment
agreements with our employees and contractors, and nondisclosure agreements with
parties with whom we conduct business in order to limit access to and disclosure
of our proprietary information. These contractual arrangements and the other
steps taken by us to protect our intellectual property may not prevent
misappropriation of our technology or deter independent third-party development
of similar technologies. We pursue the registration of our URLs, trademarks and
service marks in the U.S. and internationally. Effective copyright, service
mark, trademark, trade dress and trade secret protection is very expensive to
maintain and may require litigation. Protection may not be available in every
country in which our services are made available online. Furthermore, we must
also protect our URLs in an increasing number of jurisdictions, a process that
is expensive and may not be successful in every location. We have licensed in
the past, and expect to license in the future, certain of our proprietary
rights, such as trademarks or copyrighted material, to third parties. These
licensees may take actions that might diminish the value of our proprietary
rights or harm our reputation. We also rely on certain technologies that we
license from third parties, such as Oracle Corporation, IBM, Microsoft and Sun
Microsystems, Inc. These third-party technology licenses may not continue to be
available to us on commercially reasonable terms. The loss of these technologies
could require us to obtain substitute technologies of lower quality or
performance standards or at greater cost.
Some anti-takeover provisions may affect the price of our common stock
The Board of Directors has the authority to issue up to 10,000,000 shares of
preferred stock and to determine the preferences, rights and privileges of those
shares without any further vote or action by the stockholders. The rights of the
holders of common stock may be harmed by the rights of the holders of any
preferred stock that may be issued in the future. Some provisions of our
certificate of incorporation and bylaws could have the effect of making it more
difficult for a third party to acquire a majority of our outstanding voting
stock. These include provisions that provide for a classified board of
directors, prohibit stockholders from taking action by written consent and
restrict the ability of stockholders to call special meetings. We are also
subject to provisions of Delaware law that prohibit us from engaging in any
business combination
37
with any interested stockholder for a period of three years from the date the
person became an interested stockholder, unless certain conditions are met. This
restriction could have the effect of delaying or preventing a change of control.
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
INTEREST RATE RISK
The primary objective of our investment activities is to preserve principal
while at the same time maximizing yields without significantly increasing risk.
To achieve this objective, we maintain our portfolio of cash equivalents,
short-term and long-term investments in a variety of securities, including both
government and corporate obligations and money market funds. These securities
are generally classified as available for sale and consequently are recorded on
the balance sheet at fair value with unrealized gains or losses reported as a
separate component of accumulated other comprehensive income, net of estimated
tax.
Investments in both fixed rate and floating rate interest earning
instruments carry varying degrees of interest rate risk. Fixed rate securities
may have their fair market value adversely impacted due to a rise in interest
rates. In general, longer dated securities are subject to greater interest rate
risk than shorter dated securities. While floating rate securities generally are
subject to less interest rate risk than fixed rate securities, floating rate
securities may produce less income than expected if interest rates decrease. Due
in part to these factors, our investment income may fall short of expectations
or we may suffer losses in principal if securities are sold that have declined
in market value due to changes in interest rates. As of September 30, 2001, our
fixed income investments earned a pretax yield of approximately 4.5% and had a
weighted average maturity of 0.25 years. If interest rates were to
instantaneously increase (decrease) by 100 basis points using a duration
modeling technique, the fair market value of the total investment portfolio
could decrease (increase) by approximately $2.2 million. Assuming an average
investment balance of $850 million, if rates were to increase (decrease) by 100
basis points, this would translate to an increase (decrease) in interest income
of $8.5 million annually.
We entered into two interest rate swaps on June 19 and July 20, 2000 with
notional amounts totaling $95 million to reduce the impact of changes in
interest rates on a portion of the floating rate operating lease for our
facilities. The interest rate swaps allow for us to receive floating rate
receipts based on LIBOR in exchange for making fixed rate payments. This
effectively changes our interest rate exposure on our operating lease from a
floating rate to a fixed rate on $95 million of the total $126.4 million
operating lease. Of the $126.4 million operating lease, the interest rate is
fixed on $95 million, with the balance of $31.4 million remaining at a floating
rate of interest based on the spread over 3-month LIBOR. If the 3-month LIBOR
rates were to increase (decrease) by 100 basis points, then our lease payments
would increase (decrease) by $78,000 per quarter.
EQUITY PRICE RISK
We are exposed to equity price risk on the marketable portion of equity
investments we hold, typically as the result of strategic investments in
strategic partners as such investments are subject to considerable market risk
due to their volatility. We typically do not attempt to reduce or eliminate our
market exposure in these equity investments.
FOREIGN CURRENCY RISK
International sales are made mostly from our sales in the respective
countries by our foreign subsidiaries and are typically denominated in the local
currency of each country. These subsidiaries also incur most of their expenses
in the local currency. Accordingly, all foreign subsidiaries use the local
currency as their functional currency. Our international business is subject to
risks typical of an international business, including, but not limited to
differing economic conditions, changes in political climate, differing tax
structures, other regulations and restrictions, and foreign exchange rate
volatility. Accordingly, our future results could be materially adversely
impacted by changes in these or other factors. These financial statements are
typically denominated in the functional currency of the foreign subsidiary in
order to centralize foreign exchange risk with the parent company in the U.S. We
are also exposed to foreign exchange rate fluctuations as the financial results
of foreign subsidiaries and balance sheets are translated into U.S. dollars in
consolidation. As exchange rates vary, these results and balance sheets, when
translated, may vary from expectations and adversely impact overall expected
profitability and foreign currency translations.
38
PART II: OTHER INFORMATION
ITEM 1: LEGAL PROCEEDINGS
On April 25, 2000, we were served with a lawsuit, Gentry et.al. v. eBay,
Inc. et.al, filed in Superior Court in San Diego, California. The lawsuit was
filed on behalf of a purported class of eBay users who purchased allegedly
forged autographed sports memorabilia on eBay. The lawsuit claims we were
negligent in permitting certain named (and other unnamed) defendants to sell
allegedly forged autographed sports memorabilia on eBay. In addition, the
lawsuit claims we violated California unfair competition law and a section of
the California Civil Code which prohibits "dealers" from selling sports
memorabilia without a "Certificate of Authenticity." On January 26, 2001, the
court issued a ruling dismissing all claims against us in the lawsuit. The court
ruled that our business falls within the safe harbor provisions of 47 USC 230,
which grants Internet service providers such as eBay with immunity from state
claims based on the conduct of third parties. The court also noted that we were
not a "dealer" under California law and thus not required to provide
certificates of authenticity with autographs sold over our site by third
parties. All counts of the plaintiffs' suit were dismissed with prejudice as to
eBay. Plaintiffs have filed an appeal of this ruling. We believe we have
meritorious defenses and intend to defend ourselves vigorously.
On April 25, 2001, our European subsidiaries, eBay GmbH and eBay
International AG, were sued by Montres Rolex S.A. and certain Rolex affiliates
("Rolex") in the regional court of Cologne, Germany. Rolex alleged that our
subsidiaries were infringing Rolex's trademarks as result of users selling
counterfeit Rolex watches through our German website. The suit also alleges
unfair competition. Rolex is seeking an order forbidding the sale of Rolex
watches on the website as well as damages. We believe that we have meritorious
defenses against this claim and intend to defend ourselves vigorously.
Third parties have from time to time claimed, and may in the future claim,
that we have infringed their patents. We have in the past been forced to
litigate one such claim. On September 26, 2001 a complaint was filed by
MercExchange LLC against us, our Half.com subsidiary and ReturnBuy, Inc. in the
Eastern District of Virginia (No. 2:01-CV-736) alleging infringement of three
patents and seeking a permanent injunction and damages (including treble damages
for willful infringement). We have answered this complaint, denying the
allegations, and we believe we have meritorious defenses and will defend
ourselves vigorously.
Other third parties have from time to time claimed, in some cases through
litigation, and others may claim in the future that we have infringed their
past, current or future intellectual property rights. We may become more
vulnerable to such claims as laws such as the Digital Millennium Copyright Act
are interpreted by the courts and we expand into jurisdictions where the
underlying laws with respect to the potential liability of our online
intermediaries like ourselves is less favorable. We expect that we will
increasingly be subject to infringement claims as the geographical reach of our
services expands. These claims, whether meritorious or not, could be
time-consuming, result in costly litigation, cause service upgrade delays,
require expensive changes in our methods of doing business or could require us
to enter into costly royalty or licensing agreements, if available. As a result,
these claims could harm our business.
From time to time, we are involved in disputes arise in the ordinary course
of business. Management believes that the ultimate resolution of these disputes
will not have a material adverse impact on our consolidated financial position,
results of operations or cash flows.
ITEM 2: CHANGES IN SECURITIES AND USE OF PROCEEDS
On August 3, 2001, we completed our acquisition of HomesDirect.com, Inc., a
company that provides an online marketplace for the buying and selling of
foreclosed properties. In connection with the acquisition and in exchange for
all of the outstanding equity securities of HomesDirect, we issued a total of
108,581 shares of our common stock. The transaction was exempt from the
registration requirements of the Securities Act pursuant to Section 4(2) thereof
or Rule 506 of the rules and regulations thereunder.
ITEM 3: DEFAULTS UPON SENIOR SECURITIES
Not applicable.
39
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
ITEM 5: OTHER INFORMATION
Not applicable.
ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
None
(b) Reports on Form 8-K.
On August 24, 2001, we filed a report on Form 8-K providing the
unaudited pro forma financial statements of iBazar.
40
SIGNATURES
In accordance with the requirements of the Securities Exchange Act, the
Registrant has caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
eBay Inc.
Date: November 14, 2001
PRINCIPAL EXECUTIVE OFFICER: PRINCIPAL FINANCIAL OFFICER:
By: /s/ MARGARET C. WHITMAN By: /s/ RAJIV DUTTA
------------------------------------- ------------------------------
Margaret C. Whitman Rajiv Dutta
President and Chief Executive Officer Senior Vice President, Chief
Financial Officer
PRINCIPAL ACCOUNTING OFFICER:
By: /s/ MARK J. RUBASH
-------------------------------------
Mark J. Rubash
Vice President, Finance and Chief
Accounting Officer
41